ENSTAR GROUP LTD – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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Cautionary Statement Regarding Forward-Looking Statements

  This annual report and the documents incorporated by reference contain statements that constitute "forward-looking statements" within the meaning of Section 21E of the Exchange Act, with respect to our financial condition, results of operations, business strategies, operating efficiencies, competitive positions, growth opportunities, plans and objectives of our management, as well as the markets for our ordinary shares and the insurance and reinsurance sectors in general. Statements that include words such as "estimate," "project," "plan," "intend," "expect," "anticipate," "believe," "would," "should," "could," "seek," "may" and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise. All forward-looking statements are necessarily estimates or expectations, and not statements of historical fact, reflecting the best judgment of our management and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward looking statements should, therefore, be considered in light of various important factors, including those set forth in this annual report and the documents incorporated by reference.  

Factors that could cause actual results to differ materially from those suggested by the forward-looking statements include:

• risks associated with implementing our business strategies and initiatives;

        •   risks that we may require additional capital in the future, which may not

        be available or may be available only on unfavorable terms;    

• the adequacy of our loss reserves and the need to adjust such reserves as

        claims develop over time;    

• risks relating to the availability and collectability of our reinsurance;

• changes and uncertainty in economic conditions, including interest rates,

inflation, currency exchange rates, equity markets and credit conditions,

which could affect our investment portfolio, our ability to finance future

        acquisitions and our profitability;       •   losses due to foreign currency exchange rate fluctuations;    

• increased competitive pressures, including the consolidation and increased

        globalization of reinsurance providers;       •   emerging claim and coverage issues;    

• lengthy and unpredictable litigation affecting assessment of losses and/or

        coverage issues;    

• continued availability of exit and finality opportunities provided by

        solvent schemes of arrangement;       •   loss of key personnel;       •   the ability of our subsidiaries to distribute funds to us;    

• changes in our plans, strategies, objectives, expectations or intentions,

        which may happen at any time at management's discretion;       •   operational risks, including system or human failures and external hazards;         •   the risk that ongoing or future industry regulatory developments will

disrupt our business, or mandate changes in industry practices in ways that

increase our costs, decrease our revenues or require us to alter aspects of

        the way we do business;    

• risks relating to our acquisitions, including our ability to successfully

        price acquisitions, evaluate opportunities and address operational         challenges;                                            49 

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• risks relating to our ability to obtain regulatory approvals, including the

        timing, terms and conditions of any such approvals, and to satisfy other         closing conditions in connection with our acquisition agreements, which         could affect our ability to complete acquisitions;    

• risks relating to our ability to structure our investments in a manner that

         recognizes our liquidity needs;         •   tax, regulatory or legal restrictions or limitations applicable to us or

        the insurance and reinsurance business generally;    

• changes in tax laws or regulations applicable to us or our subsidiaries, or

the risk that we or one of our non-U.S. subsidiaries become subject to

significant, or significantly increased, income taxes in the United States

        or elsewhere;    

• changes in Bermuda law or regulation or the political stability of Bermuda;

        and       •   changes in accounting policies or practices.   The factors listed above should be not construed as exhaustive and should be read in conjunction with the Risk Factors that are included in Item 1A above. We undertake no obligation to publicly update or review any forward looking statement, whether to reflect any change in our expectations with regard thereto, or as a result of new information, future developments or otherwise, except as required by law.  Business Overview  We are a Bermuda-based company that acquires and manages insurance and reinsurance companies in run-off and portfolios of insurance and reinsurance business in run-off, and provides management, consulting and other services to the insurance and reinsurance industry.  

Since our formation in August 2001, we have acquired 36 insurance and reinsurance companies and 21 portfolios of insurance and reinsurance business and are now administering those businesses in run-off.

  We operate our business internationally through our insurance and reinsurance subsidiaries and our consulting subsidiaries in Bermuda, the United States, the United Kingdom, Australia and Europe. We had a total of 383 employees as at December 31, 2012.  

Key Performance Indicators

  The financial measure that we believe is most meaningful in analyzing our performance and assessing whether we are achieving our objectives is growth in book value per share. As of December 31, 2012 and 2011, book value per share and diluted book value per share were as follows:                                                   As of             As of                                            December 31,      December 31,                                                2012              2011             Book value per share           $       94.29     $       84.56             Diluted book value per share   $       93.30     $       82.97   Our principal business consists of acquiring and managing property and casualty insurance and reinsurance companies that have ceased underwriting new business - meaning they are in "run-off." We believe growth in our net book value is driven primarily by growth in our net earnings, which is in turn driven in large part by successfully completing new acquisitions and effectively managing companies and portfolios of business that we previously acquired. We generate our earnings in the following ways:   

• settling net loss reserves of acquired businesses below their acquired fair

        value;         •   generating investment income on the cash and investment portfolios of         acquired businesses;                                            50 

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• in some cases, purchasing companies at a discount to the fair value of the

assets acquired, which has resulted in the recording of gains on bargain

        purchases; and         •   providing expert run-off management services for a fixed and/or

incentive-based fee in cases where vendors are not ready or able to dispose

of their run-off operations, but require third-party services to stabilize

        the business and, where possible, add value to the core business.   During the year ended December 31, 2012, our book value per share on a basic and diluted basis increased by 11.5% and 12.5%, respectively. The increase in both basic and diluted book value per share was principally due to our net earnings for the year.  Drivers of Profitability 

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities

  Our insurance-related earnings comprise primarily reductions, or potential increases, of net ultimate loss and loss adjustment expense liabilities. These liabilities are comprised of outstanding loss or case reserves (or OLR), losses incurred but not reported (or IBNR) and unallocated loss adjustment expenses (or ULAE) reserves.  Net ultimate loss and loss adjustment expense liabilities established by management utilizing analysis performed by independent actuaries prepared on an annual basis are reviewed by our management each quarter. Reserves reflect management's best estimate of the remaining unpaid portion of these liabilities. Prior period estimates of net ultimate loss and loss adjustment expense liabilities may change as our management considers the combined impact of commutations, policy buy-backs, settlement of losses on carried reserves and the trend of incurred loss development compared to prior forecasts. Net reductions in ultimate loss and loss adjustment expense liabilities are reported as negative expenses by us. For more information on how the reserves are calculated, see "- Critical Accounting Policies - Loss and Loss Adjustment Expenses" on page 54.  

Net Investment Income and Net Realized and Unrealized Gains

  Our net investment income is a function of the average invested assets and the average yield that we earn on those invested assets. The investment yield on our fixed maturity investments is a function of market interest rates as well as the credit quality and duration of our fixed maturities portfolio. Our net realized and unrealized gains or losses on investments includes realized gains and losses on our fixed maturity securities and changes in fair value of our trading securities and other investments. We recognize realized gains and losses at the time of sale, and these gains and losses, along with the changes in fair value of our trading securities, reflect the results of changing market conditions, including changes in market interest rates and changes in the market's perception of the credit quality of our fixed maturity holdings. The change in fair value of other investments is principally a function of the success of the funds in which we are invested, which depends on, among other things, the underlying strategies of the funds, the ability of the fund managers to execute the fund strategies and general economic and investment market conditions.  

Consulting Fee Income

  We generate consulting fees based on a combination of fixed and success-based fee arrangements. Consulting income will vary from period to period depending on the timing of completion of success-based fee arrangements. Success-based fees are recorded when targets related to overall project completion or profitability goals are achieved.  Expenses  Salaries and Benefits  We are a service-based company and, as such, employee salaries and benefits are our largest expense. We have experienced significant increases in our salaries and benefits expenses as we have grown our operations, and we expect that trend to continue if we are able to expand our operations successfully.                                           51

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  We provide for the annual grant of bonus compensation to our officers and employees, including our senior executive officers. Bonus awards are based on a percentage of our consolidated net after-tax profits. The percentage is 15% unless our Compensation Committee exercises its discretion to change the percentage no later than 30 days after our year end. Bonus awards are payable in cash, ordinary shares or a combination of both.  

General and Administrative Expenses

  General and administrative expenses include rent and rent-related costs, professional fees (legal, investment, audit and actuarial) and travel expenses. We have operations in multiple jurisdictions and our employees travel frequently in connection with the search for acquisition opportunities and in the general management of the business.  Income Taxes 

We have operations in multiple jurisdictions where our subsidiaries are subject to taxation. Income tax expense is generated through our foreign operations outside of Bermuda. Our income tax expense will fluctuate depending on the geographic distribution of pre-tax net income.

Net Earnings Attributable to Noncontrolling Interest

  Net earnings attributable to noncontrolling interest relates to the share of earnings of seven of our subsidiaries that is not attributable to us because a third party has an interest in such subsidiaries.  

Critical Accounting Policies

We believe the following accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements.

Accounting for Acquisitions - Fair Value Measurement

We use the purchase method in accounting for acquisitions. The difference between the fair value of net assets acquired and purchase price is recorded as goodwill.

  The most significant liability of an acquired company is typically the liability for loss and loss adjustment expenses, and the most significant asset is typically the asset related to any reinsurance recoverable on these liabilities that may be contractually due to the acquired entity. The market for acquisition of run-off companies is not sufficiently active and transparent to enable us to identify reliable, market exit values for acquired assets and liabilities. Accordingly, consistent with provisions of U.S. GAAP, we have developed internal models that we believe allow us to determine fair values that are reasonable proxies for market exit values. We are familiar with the major participants in the acquisition run-off market and believe that the key assumptions we make in valuing acquired assets and liabilities are consistent with the kinds of assumptions made by such market participants. Furthermore, in our negotiation of purchase price with sellers, it is frequently clear to us that other bidders in the market are using models and assumptions similar in nature to ours during the competitive bid process. The majority of acquisitions are completed following a public tender process whereby the seller invites market participants to provide bids for the target acquisition.  We account for acquisitions using the purchase method of accounting, which requires that the acquirer record the assets and liabilities acquired at their estimated fair value. The fair values of each of the reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and management's run-off strategy. Our run-off strategy, as well as that of other run-off market participants, is expected to be different from the seller's as generally sellers are not specialized in running off insurance and reinsurance liabilities whereas we and other market participants do specialize in such run-offs.                                           52 

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  The key assumptions used by us and, we believe, by other run-off market participants in the fair valuation of acquired companies are (i) the projected payout, timing and amounts of claims liabilities; (ii) the related projected timing and amount of reinsurance collections; (iii) a risk-free discount rate, which is applied to determine the present value of the future cash flows; (iv) the estimated unallocated loss adjustment expenses to be incurred over the life of the run-off; (v) the impact of any accelerated run-off strategy; and (vi) an appropriate risk margin.  The probability-weighted projected cash flows of the acquired company are based on projected claims payouts provided by the seller predominantly in the form of the seller's most recent independent actuarial reserve report. In the absence of the seller's actuarial reserve report, our independent actuaries will determine the estimated claims payout.  With respect to our U.K., Bermudian and Australian insurance and reinsurance subsidiaries, we are able to pursue strategies to achieve complete finality and conclude the run-off of a company by promoting solvent schemes of arrangement. Solvent schemes of arrangement are a popular means of achieving financial certainty and finality for insurance and reinsurance companies incorporated or managed in the U.K., Bermuda and Australia by making a one-time full and final settlement of an insurance and reinsurance company's liabilities to policyholders. On acquisition of a U.K., Bermudian or Australian company, the claims payout projection is weighted according to management's estimated probability of being able to complete a solvent scheme of arrangement. To the extent that solvent schemes of arrangement are not available to an acquired company, no weighting is applied to the projected claims payout.  On acquisition, we make a provision for unallocated loss adjustment expense liabilities. This provision considers the adequacy of the provision maintained and recorded by the seller in light of our run-off strategy and estimated unallocated loss adjustment expenses to be incurred over the life of the acquired run-off as projected by the seller's actuaries or, in their absence, our actuaries. To the extent that our estimate of the total unallocated loss adjustment expense provision is different from the seller's, an adjustment will be made. While it is our objective to accelerate the run-off by completing commutations of assumed and ceded business (which would have the effect of shortening the life, and therefore the cost, of the run-off), the success of this strategy is far from certain. Therefore, the estimates of unallocated loss adjustment expenses are based on running off the liabilities and assets over the actuarially projected life of the run-off. In those domiciles where solvent schemes of arrangement are available, management's estimates of the total unallocated loss adjustment expenses are probability-weighted in accordance with the estimated time that a solvent scheme of arrangement could be completed, which has the effect of reducing the period of the run-off and the related unallocated loss adjustment expenses. For those acquisitions in domiciles where solvent schemes of arrangement are not available, the unallocated loss adjustment expenses are estimated over the projected life of the run-off.  We believe that providing for unallocated loss adjustment expenses based on our run-off strategy is appropriate in determining the fair value of the assets and liabilities acquired in an acquisition of a run-off company. We believe that other participants in the run-off acquisition marketplace factor into the price to pay for an acquisition the estimated cost of running off the acquired company based on how that participant expects to manage the assets and liabilities.  The difference between the original carrying value of reinsurance liabilities and reinsurance assets acquired at the date of acquisition and the fair value is recorded as an intangible asset or other liability, which we refer to as the Fair Value Adjustment, or FVA. The FVA is amortized over the estimated payout period and adjusted for accelerations on commutation settlements or any other new information or subsequent change in circumstances after the date of acquisition. To the extent the actual payout experience after the acquisition is materially faster or slower than anticipated at the time of the acquisition, there is an adjustment to the estimated ultimate loss reserves, or there are changes in bad debt provisions or in estimates of future run-off costs following accelerated payouts, then the amortization of the FVA is accelerated or decelerated, as the case may be, to reflect such changes. The FVA is tested annually for impairment.                                           53 

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Loss and Loss Adjustment Expenses

  Our primary objective in running off the operations of acquired companies and portfolios of insurance and reinsurance business in run-off is to increase book value by settling loss reserves below their acquired fair value. The earnings created in each acquired company or portfolio of insurance and reinsurance business, together with the related decrease in loss reserves, lead to a reduction in the capital required for each company, thereby providing the ability to distribute both earnings and excess capital to the parent company.  To the extent that the nature of the acquired loss reserves are conducive to commutation, our aim is to settle the majority of the acquired loss reserves within a timeframe of approximately five to seven years from the date of acquisition. To the extent that acquired reserves are not conducive to commutation, we will instead adopt a disciplined claims management approach to pay only valid claims on a timely basis and endeavor to reduce the level of acquired loss adjustment expense provisions by withdrawing, where appropriate, from existing litigation and otherwise streamlining claims handling procedures.  By adopting either of the above run-off strategies, we would expect that over the targeted life of the run-off, acquired ultimate loss reserves would settle below their recorded fair value, resulting in reductions in ultimate loss and loss adjustment expense liabilities. There can be no assurance, however, that we will successfully implement our strategy.  

Commutations of blocks of policies, along with disciplined claims management, have the potential to produce favorable claims development compared to established reserves. For each newly-acquired company, we determine a commutation strategy that broadly identifies commutation targets using the following criteria:

        •   Previous commutations completed by existing portfolio companies with         policyholders of the newly-acquired company;       •   Nature of liabilities;       •   Size of incurred loss reserves;       •   Recent loss development history; and       •   Targets for claims audits.   Once commutation targets are identified, they are prioritized into target years of completion. At the beginning of each year, the approach to commutation negotiations is determined by the commutation team, including claims and exposure analysis and broker account reconciliations. On completion of this analysis, settlement parameters are set around incurred liabilities. Commutation discussions can take many months or even years to come to fruition. Commutation targets not completed in a particular year are re-prioritized for the following year.  Every commutation, irrespective of value, requires the approval of our Chief Financial Officer or one of our two Joint Chief Operating Officers. The impact of the commutation activity on the IBNR reserve is reflected as part of our annual actuarial reviews of reserves. However, if a significant commutation is completed during the year, loss reserves will be adjusted in the corresponding quarter to reflect management's then best estimate of the impact on remaining IBNR reserves.                                           54 

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The following table provides a breakdown of gross loss and loss adjustment expense reserves by type of exposure as of December 31, 2012 and 2011:

                                                     2012                                            2011                                    OLR            IBNR            Total            OLR            IBNR            Total                                                              (in thousands of U.S. dollars) Asbestos                       $   179,917     $   355,006     $   534,923     $   207,288     $   386,147     $   593,435 Environmental                       51,632          42,088          93,720          67,040          42,326         109,366 All other: General casualty                   565,250         384,640         949,890         550,012         533,504       1,083,516 Workers compensation/personal accident                           652,034         135,966         788,000         707,723         349,061       1,056,784 Marine, aviation and transit       163,367          26,898         190,265         238,209          43,686         281,895 Construction defect                 92,279         150,520         242,799         120,258         182,583         302,841 Other                              500,472         127,896         628,368         466,397         137,380         603,777  Total all other                  1,973,402         825,920       2,799,322       2,082,599       1,246,214       3,328,813  Total                          $ 2,204,951     $ 1,223,014     $ 3,427,965     $ 2,356,927     $ 1,674,687     $ 4,031,614  Unallocated loss adjustment expenses                                                           233,189                                         251,302  Total                                                          $ 3,661,154                                     $ 4,282,916    The following table provides a breakdown of loss and loss adjustment expense reserves (net of reinsurance balances recoverable) by type of exposure as of December 31, 2012 and 2011:                                                              2012                             2011                                                    Total           % of             Total            % of                                                 Net Reserves       Total         Net Reserves        Total                                                               (in thousands of U.S. dollars) Asbestos                                       $      478,154        17.2 %     $      528,398         18.2 % Environmental                                          79,397         2.9 %             93,089          3.2 % All other: General casualty                                      728,976        26.2 %            659,821         22.8 % Workers compensation/personal accident                451,980        16.2 %            643,543         22.2 % Marine, aviation and transit                          140,412         5.0 %            171,664          5.9 % Construction defect                                   145,700         5.2 %            184,419          6.4 % Other                                                 527,127        18.9 %            367,677         12.6 %  Total all other                                     1,994,195        71.5 %          2,027,124         69.9 % Unallocated loss adjustment expenses                  233,189         8.4 %            251,302          8.7 %  Total                                          $    2,784,935       100.0 %     $    2,899,913        100.0 %   

As of December 31, 2012, the IBNR reserves (net of reinsurance balances recoverable) accounted for $939.7 million, or 33.7%, of our total net loss reserves. The reserve for IBNR (net of reinsurance balance recoverable) accounted for $1,038.9 million, or 35.8%, of our total net loss reserves at December 31, 2011.

Annual Loss and Loss Adjustment Reviews

  Because a significant amount of time can lapse between the assumption of risk, the occurrence of a loss event, the reporting of the event to an insurance or reinsurance company and the ultimate payment of the claim on the loss event, the liability for unpaid losses and loss adjustment expenses is based largely upon estimates.                                           55 

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  Our management must use considerable judgment in the process of developing these estimates. The liability for unpaid losses and loss adjustment expenses for property and casualty business includes amounts determined from loss reports on individual cases and amounts for IBNR reserves. Such reserves, including IBNR reserves, are estimated by management based upon loss reports received from ceding companies, supplemented by our own estimates of losses for which no ceding company loss reports have yet been received and the results of annual independent actuarial studies.  Loss advices or reports from ceding companies are generally provided via the placing broker and comprise treaty statements, individual claims files, electronic messages and large loss advices or cash calls. Large loss advices and cash calls are provided to us as soon as practicable after an individual loss or claim is made or settled by the insured. The remaining broker advices are issued monthly, quarterly or annually depending on the provisions of the individual policies or the ceding company's practice. For certain direct insurance policies where the claims are managed by Third Party Administrators (TPA's) and Managing General Agents (MGA's), loss bordereaux are received either monthly or quarterly depending on the arrangement with the TPA and MGA.  Where we provide reinsurance or retrocession reinsurance protection, the process of claim advice from the direct insurer to the reinsurers and/or retrocessionaires naturally involves more levels of communication, which inevitably creates delays or lags in the receipt of loss advice by the reinsurers/retrocessionaires relative to the date of first advice to the direct insurer. Certain types of exposure, typically latent health exposures such as asbestos-related claims, have inherently long reporting delays, in some cases many years, from the date a loss occurred to the manifestation and reporting of a claim and ultimately until the final settlement of the claim. For asbestos and environmental exposures, our actuaries apply explicit time lag assumptions in their reserving methodologies. This time lag varies by portfolio from one to five years depending on the relative mix of domicile, percentages of product mix of insurance, reinsurance and retrocessional reinsurance, primary insurance, excess reinsurance, reinsurance of direct and reinsurance of reinsurance within any given exposure category. Exposure portfolios written from a non-US domicile are assumed to have a greater time lag than portfolios written from a US-domicile. Portfolios with a larger proportion of reinsurance exposures are assumed to have a greater time-lag than portfolios with a larger proportion of insurance exposures.  An industry-wide weakness in cedant reporting affects the adequacy and accuracy of reserving for advised claims. We attempt to mitigate this inherent weakness as follows:   

1. We closely monitor cedant loss reporting and, for those cedants identified

        as providing inadequate, untimely or unusual reporting of losses, we         conduct, in accordance with the provisions of the insurance and         reinsurance contracts, detailed claims audits at the insured's or

reinsured's premises. Such claims audits have the benefit of validating

advised claims, determining whether the cedant's loss reserving practices

and reporting are adequate and identifying potential loss reserving issues

of which our actuaries need to be made aware. Any required adjustments to

advised claims reserves reported by cedants identified during the claims

audits will be recorded as an adjustment to the advised case reserve.

        2.  Onsite claims audits are often supplemented by further reviews by our

internal and external legal advisors to determine the reasonableness of

        advised case reserves and, if considered necessary, an adjustment to the         reported case reserve will be recorded.    

3. Our actuaries project expected paid and incurred loss development for each

class of business, which is monitored on a quarterly basis. Should actual

paid and incurred development differ significantly from the expected paid

        and incurred development, we will investigate the cause and, in         conjunction with our actuaries, consider whether any adjustment to         ultimate loss reserves is required.  

Our actuaries consider the quality of ceding company data as part of their ongoing evaluation of the liability for ultimate losses and loss adjustment expenses, and the methodologies they select for estimating ultimate losses inherently compensate for potential weaknesses in this data, including weaknesses in loss reports provided by cedants.

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  We strive to apply the highest standards of discipline and professionalism to our claims adjusting, processing and settlement and disputes with cedants are rare. However, we are from time to time involved in various disputes and legal proceedings in the ordinary course of our claims adjusting process. The majority of the losses ceded to us are from the subscription insurance market (where there are often many insurers and reinsurers underwriting each policy), and we often are involved in disputes commenced by other co-insurers who act in unison with any litigation or dispute resolution controlled by the lead underwriter. Coverage disputes arise when the insured/reinsured and insurer/reinsurer cannot reach agreement as to the interpretation of the policy and/or application of the policy to a claim. Most insurance and reinsurance policies contain dispute resolution clauses requiring arbitration or mediation. In the absence of a contractual dispute resolution process, civil litigation would be commenced. We aim to reach a commercially acceptable resolution to any dispute, using arbitration or litigation as a last resort. We regularly monitor and provide internal reports on disputes involving arbitration and litigation and engage external legal counsel to provide professional advice and assist with case management.  In establishing reserves, management includes amounts for IBNR reserves using information from independent actuarial estimates of ultimate losses. Our independent actuaries use generally accepted actuarial methodologies to estimate ultimate losses and loss adjustment expenses and those estimates are reviewed by our management.  

Nearly all of our unpaid claims liabilities are considered to have a long claims payout tail. Gross loss reserves relate primarily to casualty exposures, including latent claims, of which approximately 18% relate to asbestos and environmental, or A&E, exposures.

  Within the annual loss reserve studies produced by our independent actuaries, exposures for each subsidiary are separated into homogeneous reserving categories for the purpose of estimating IBNR. Each reserving category contains either direct insurance or assumed reinsurance reserves and groups relatively similar types of risks and exposures (for example, asbestos, environmental, casualty, property) and lines of business written (for example, marine, aviation, non-marine). Based on the exposure characteristics and the nature of available data for each individual reserving category, a number of methodologies are applied. Recorded reserves for each category are selected from the indications produced by the various methodologies after consideration of exposure characteristics, data limitations and strengths and weaknesses of each method applied. This approach to estimating IBNR has been consistently adopted in the annual loss reserve studies for each period presented.  We review the external actuaries' reports for consistency and appropriateness of methodology and assumptions, including assumptions of industry benchmarks, and discuss any concerns or changes with them. Our Chief Actuary and Chief Financial Officer then consider the reasonableness of loss reserves recommended by our external actuaries, in light of actual loss development during the year, using the following reports produced internally on a quarterly basis for each of our insurance and reinsurance subsidiaries:    

1. Gross, ceded and net incurred loss report - This report provides, for each

reporting period, the total (including commuted policies) gross, ceded and

        net incurred loss development for each company and a commentary on each         company's loss development prepared by our Chief Actuary. The report

highlights the causes of any unusual or significant loss development

activity (including commutations) and includes commentary on quality and

        reliability of underlying data.    

2. Actual versus expected gross incurred loss development report - This

report provides a summary, and commentary thereon, of each company's

(excluding companies or portfolios of business acquired in the current

year) non-commuted incurred gross losses compared to the estimate of the

development of non-commuted incurred gross losses provided by our external

        actuaries at the beginning of the year as part of the prior year's         reserving process.    

3. Commutations summary schedule - This schedule summarizes all commutations

completed during the year for all companies, and identifies the

policyholder with which we commuted, the incurred losses settled by the

commutation (comprising outstanding unpaid losses and case reserves) and

        the amount of the commutation settlement.                                            57 

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4. Analysis of paid, incurred and ultimate losses - This analysis for each

company, and in the aggregate, provides a summary of the gross, ceded and

net paid and incurred losses and the impact of applying our external

actuaries' recommended loss reserves. This report, reviewed in conjunction

        with the previous reports, provides an analytical tool to review each         company's incurred loss or gain and reduction in IBNR reserves to assess         whether the ultimate reduction in loss reserves appears reasonable in         light of known developments within each company.   The above reports provide our Chief Actuary and Chief Financial Officer with the relevant information to determine whether loss development (including commutations) during the year has, for each company, been sufficiently meaningful so as to warrant an adjustment to the reserves recommended by our external actuaries in the most recent actuarial study. It is not possible to quantify how much of any reserve release specifically relates to commutations or favorable development of non-commuted claims as the revised historical loss development used by the actuaries to estimate required reserves is a combination of both the elimination of historical loss development relating to commuted policies and non-commuted loss development.  When establishing loss reserves we have an expectation that, in the absence of commutations and significant favorable or unfavorable non-commuted loss development compared to expectations, loss reserves will not exceed the high, or be less than the low, end of the following ranges of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance subsidiaries as of December 31, 2012.  The ranges of gross loss and loss adjustment expense reserves implied by the various methodologies used by each of our insurance and reinsurance subsidiaries as of December 31, 2012 were:                                                    Low          Selected          High                                                   (in thousands of U.S. dollars)    Asbestos                                 $   475,580     $   534,923     $   600,166    Environmental                                 83,529          93,720         105,047    All other:    General casualty                             841,928         949,890       1,054,440

Workers compensation/personal accident 695,520 788,000

876,384

    Marine, aviation and transit                 161,938         190,265         196,314    Construction defect                          210,425         242,799         280,161    Other                                        562,736         628,368         692,207     Total all other                            2,472,547       2,799,322       3,099,506

Unallocated loss adjustment expenses 233,189 233,189

    233,189     Total                                    $ 3,264,845     $ 3,661,154     $ 4,037,908    Latent Claims  Our loss reserves are related largely to casualty exposures including latent exposures relating primarily to A&E. In establishing the reserves for unpaid claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy and management can reasonably estimate its liability. In addition, reserves are established to cover loss development related to both known and unasserted claims.  The estimation of unpaid claim liabilities is subject to a high degree of uncertainty for a number of reasons. First, unpaid claim liabilities for property and casualty exposures in general are impacted by changes in the legal environment, jury awards, medical cost trends and general inflation. Moreover, for latent exposures in particular, developed case law and adequate claim history do not exist. There is significant coverage litigation related to                                           58

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  these exposures, which creates further uncertainty in the estimation of the liabilities. As a result, for these types of exposures, it is especially unclear whether past claim experience will be representative of future claim experience. Ultimate values for such claims cannot be estimated using reserving techniques that extrapolate losses to an ultimate basis using loss development factors, and the uncertainties surrounding the estimation of unpaid claim liabilities are not likely to be resolved in the near future. There can be no assurance that the reserves we establish will be adequate or will not be adversely affected by the development of other latent exposures.  Our asbestos claims are primarily products liability claims submitted by a variety of insureds who operated in different parts of the asbestos distribution chain. While most such claims arise from asbestos mining and primary asbestos manufacturers, we have also been receiving claims from tertiary defendants such as smaller manufacturers, and the industry has seen an emerging trend of non-products claims arising from premises exposures. Unlike products claims, primary policies generally do not contain aggregate policy limits for premises claims, which, accordingly, remain at the primary layer and, thus, rarely impact excess insurance policies. As the vast majority of our policies are excess policies, this trend has had only a marginal effect on our asbestos exposures thus far.  Asbestos reform efforts have been underway at both the federal and state level to address the cost and scope of asbestos claims to the American economy. While congressional efforts to create a federal trust fund that would replace the tort system for asbestos claims failed, several states, including Texas and Florida, have passed reforms based on "medical criteria" requiring certain levels of medically documented injury before a lawsuit can be filed, generally resulting in a drop of case filings in those states adopting this reform measure.  Asbestos claims primarily fall into two general categories: impaired and unimpaired bodily injury claims. Property damage claims represent only a small fraction of asbestos claims. Impaired claims primarily include individuals suffering from mesothelioma or a cancer such as lung cancer. Unimpaired claims include asbestosis and those whose lung regions contain pleural plaques.  Unlike traditional property and casualty insurers that either have large numbers of individual claims arising from personal lines such as auto, or small numbers of high value claims as in medical malpractice insurance lines, our primary exposures arise from A&E claims that do not follow a consistent pattern. For instance, we may encounter a small insured with one large environmental claim due to significant groundwater contamination, while a Fortune 500 company may submit numerous claims for relatively small values. Moreover, there is no set pattern for the life of an environmental or asbestos claim. Some of these claims may resolve within two years whereas others have remained unresolved for nearly two decades. Therefore, our open and closed claims data do not follow any identifiable or discernible pattern.  Furthermore, because of the reinsurance nature of the claims we manage, we focus on the activities at the reinsured level rather than at the individual claims level. The counterparties with whom we typically interact are generally insurers or large industrial concerns and not individual claimants. Claims do not follow any consistent pattern. They arise from many insureds or locations and in a broad range of circumstances. An insured may present one large claim or hundreds or thousands of small claims. Plaintiffs' counsel frequently aggregate thousands of claims within one lawsuit. The deductibles to which claims are subject vary from policy to policy and year to year. Often claims data is only available to reinsurers, such as us, on an aggregated basis. Accordingly, we have not found claim count information or average reserve amounts to be reliable indicators of exposure for our reserve estimation process or for management of our liabilities. We have found data accumulation and claims management more effective and meaningful at the reinsured level rather than at the underlying claim level. As a result, we have designed our reserving methodologies to be independent of claim count information. As the level of exposures to a reinsured can vary substantially, we focus on the aggregate exposures and pursue commutations and policy buy-backs with the larger reinsureds.  

As of December 31, 2012, we employed approximately 27 full-time equivalent employees, including attorneys, actuaries, and experienced claims-handlers, to directly administer our A&E liabilities.

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Our future environmental loss development may be influenced by other factors including:

• Existence of currently undiscovered polluted sites eligible for clean-up

         under the Comprehensive Environmental Response, Compensation, and          Liability Act (or CERCLA) and related legislation.    

• Costs imposed due to joint and several liability if not all potentially

         reliable parties (or PRPs) are capable of paying their share.    

• Success of legal challenges to certain policy terms such as the "absolute"

          pollution exclusion.          •   Potential future reforms and amendments to CERCLA, particularly as the          resources of Superfund - the funding vehicle, established as part of          CERCLA, to provide financing for cleanup of polluted sites where no PRP          can be identified - become exhausted.   The influence of each of these factors is not easily quantifiable and, as with asbestos-related exposures, our historical environmental loss development is of limited value in determining future environmental loss development using traditional actuarial reserving techniques.  There have been recent positive developments concerning lead paint liability, an area previously viewed as an emerging trend in latent claim activity with the potential to adversely affect reserves. After a series of successful defense efforts by defendant lead pigment manufacturers in lead paint litigation, in 2005, a Rhode Island trial court ruled in favor of the government in a nuisance claim against the defendant manufacturers. Since the Rhode Island decision, other government entities have employed the same theory for recovery against these manufacturers. In 2008, the Rhode Island Supreme Court reversed the sole legal liability loss experienced by lead pigment manufacturers in lead paint litigation. The court rejected public nuisance as a viable theory of liability for use by the government against the defendants and thus invalidated the entire claim against the lead pigment manufacturers. Subsequent to the Rhode Island Supreme Court decision at least one other government entity, an Ohio municipality, voluntarily dropped its lead paint suit. Thereafter, the State of Ohio, voluntarily dismissed its pending action against lead pigment manufacturers. Other state supreme courts equally rejected the public nuisance theory of liability, whereas no highest state court has ever adopted this theory as an acceptable cause of action.  We believe that lead paint claims now pose a lower risk to adverse reserve adjustment than previously thought, as the only trial court decision against lead pigment manufacturers to date was reversed on the basis that public nuisance is an improper liability theory by which a plaintiff may seek recovery against the lead pigment manufacturers. Even if adverse rulings under alternative theories succeed or if other states ultimately permit recovery under a public nuisance theory, it is questionable whether insureds have coverage under their policies under which they seek indemnity. Insureds have yet to meet policy terms and conditions to establish coverage for lead paint public nuisance claims, as opposed to traditional bodily injury and property damage claims. Still, there is the potential for significant impact to excess insurers should plaintiffs prevail in successive nuisance claims pending in other jurisdictions and coverage is established.  Our independent, external actuaries use industry benchmarking methodologies to estimate appropriate IBNR reserves for our A&E exposures. These methods are based on comparisons of our loss experience on A&E exposures relative to industry loss experience on A&E exposures. Estimates of IBNR are derived separately for each of our relevant subsidiaries and, for some subsidiaries, separately for distinct portfolios of exposure. The discussion that follows describes, in greater detail, the primary actuarial methodologies used by our independent actuaries to estimate IBNR for A&E exposures.  In addition to the specific considerations for each method described below, many general factors are considered in the application of the methods and the interpretation of results for each portfolio of exposures. These factors include the mix of product types (e.g., primary insurance versus reinsurance of primary versus reinsurance of reinsurance), the average attachment point of coverages (e.g., first-dollar primary versus umbrella over primary versus high-excess), payment and reporting lags related to the international domicile of our                                           60

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  subsidiaries, payment and reporting pattern acceleration due to large "wholesale" settlements (e.g., policy buy-backs and commutations) pursued by us, and lists of individual risks remaining and general trends within the legal and tort environments.  1. Paid Survival Ratio Method.  In this method, our expected annual average payment amount is multiplied by an expected future number of payment years to get an indicated reserve. Our historical calendar year payments are examined to determine an expected future annual average payment amount. This amount is multiplied by an expected number of future payment years to estimate a reserve. Trends in calendar year payment activity are considered when selecting an expected future annual average payment amount. Accepted industry benchmarks are used in determining an expected number of future payment years. Each year, annual payments data is updated, trends in payments are re-evaluated and changes to benchmark future payment years are reviewed. Advantages of this method are of ease of application and simplicity of assumptions. A potential disadvantage of the method is that results could be misleading for portfolios of high excess exposures where significant payment activity has not yet begun.  2. Paid Market Share Method.  In this method, our estimated market share is applied to the industry estimated unpaid losses. The ratio of our historical calendar year payments to industry historical calendar year payments is examined to estimate our market share. This ratio is then applied to the estimate of industry unpaid losses. Each year, calendar year payment data is updated (for both us and industry), estimates of industry unpaid losses are reviewed and the selection of our estimated market share is revisited. This method has the advantage that trends in calendar year market share can be incorporated into the selection of company share of remaining market payments. A potential disadvantage of this method is that it is particularly sensitive to assumptions regarding the time-lag between industry payments and our payments.  3. Reserve-to-Paid Method.  In this method, the ratio of estimated industry reserves to industry paid-to-date losses is multiplied by our paid-to-date losses to estimate our reserves. Specific considerations in the application of this method include the completeness of our paid-to-date loss information, the potential acceleration or deceleration in our payments (relative to the industry) due to our claims handling practices, and the impact of large individual settlements. Each year, paid-to-date loss information is updated (for both us and the industry) and updates to industry estimated reserves are reviewed. This method has the advantage of relying purely on paid loss data and so is not influenced by subjectivity of case reserve loss estimates. A potential disadvantage is that the application to our portfolios that do not have complete inception-to-date paid loss history could produce misleading results. To address this potential disadvantage, a variation of the method is also considered by multiplying the ratio of estimated industry reserves to industry losses paid during a recent period of time (e.g., 5 years) times our paid losses during that period.  4. IBNR:Case Ratio Method.  In this method, the ratio of estimated industry IBNR reserves to industry case reserves is multiplied by our case reserves to estimate our IBNR reserves. Specific considerations in the application of this method include the presence of policies reserved at policy limits, changes in overall industry case reserve adequacy and recent loss reporting history. Each year, our case reserves are updated, industry reserves are updated and the applicability of the industry IBNR:Case Ratio is reviewed. This method has the advantage that it incorporates the most recent estimates of amounts needed to settle open cases included in current case reserves. A potential disadvantage is that results could be misleading where our case reserve adequacy differs significantly from overall industry case reserve adequacy.  5. Ultimate-to-Incurred Method.  In this method, the ratio of estimated industry ultimate losses to industry incurred-to-date losses is applied to our incurred-to-date losses to estimate our IBNR reserves. Specific considerations in the application of this method include the completeness of our incurred-to-date loss information, the potential acceleration or deceleration in our incurred losses (relative to the industry) due to our claims handling practices and the impact of large individual settlements. Each year incurred-to-date loss information is updated (for both us and the industry) and updates to industry estimated ultimate losses are reviewed. This method has the advantage that it incorporates both paid and case reserve information in projecting                                           61 

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  ultimate losses. A potential disadvantage is that results could be misleading where cumulative paid loss data is incomplete or where our case reserve adequacy differs significantly from overall industry case reserve adequacy.  Under the Paid Survival Ratio Method, the Paid Market Share Method and the Reserve-to-Paid Method, we first determine the estimated total reserve and then deduct the reported outstanding case reserves to arrive at an estimated IBNR reserve. The IBNR:Case Ratio Method first determines an estimated IBNR reserve which is then added to the advised outstanding case reserves to arrive at an estimated total loss reserve. The Ultimate-to-Incurred Method first determines an estimate of the ultimate losses to be paid and then deducts paid-to-date losses to arrive at an estimated total loss reserve and then deducts outstanding case reserves to arrive at the estimated IBNR reserve.  

As of December 31, 2012, we had 30 separate insurance and/or reinsurance subsidiaries whose reserves are categorized into approximately 311 reserve categories in total, including 38 distinct asbestos reserving categories and 25 distinct environmental reserving categories.

  To the extent that data availability allows, the five methodologies described above are applied for each of the 38 asbestos reserving categories and each of the 25 environmental reserving categories. As is common in actuarial practice, no one methodology is exclusively or consistently relied upon when selecting a recorded reserve. Consistent reliance on a single methodology to select a recorded reserve would be inappropriate in light of the dynamic nature of both the A&E liabilities in general, and our actual exposure portfolios in particular.  In selecting a recorded reserve, management considers the range of results produced by the methods, and the strengths and weaknesses of the methods in relation to the data available and the specific characteristics of the portfolio under consideration. Trends in both our data and industry data are also considered in the reserve selection process. Recent trends or changes in the relevant tort and legal environments are also considered when assessing methodology results and selecting an appropriate recorded reserve amount for each portfolio.  

The following key assumptions were used to estimate A&E reserves at December 31, 2012:

        1.  $65 Billion Ultimate Industry Asbestos Losses - This level of 

industry-wide losses and its comparison to industry-wide paid, incurred

and outstanding case reserves is the base benchmarking assumption applied

        to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the         Ultimate-to-Incurred asbestos reserving methodologies.         2.  $38.5 Billion Ultimate Industry Environmental Losses - This level of

industry-wide losses and its comparison to industry-wide paid, incurred

and outstanding case reserves is the base benchmarking assumption applied

        to Paid Market Share, Reserve-to-Paid, IBNR:Case Ratio and the         Ultimate-to-Incurred environmental reserving methodologies.    

3. Loss Reporting Lag - Our subsidiaries assumed a mix of insurance and

reinsurance exposures generally through the London market. As the

available industry benchmark loss information, as supplied by our

independent consulting actuaries, is compiled largely from U.S. direct

insurance company experience, our loss reporting is expected to lag

relative to available industry benchmark information. This time-lag used

by each of our insurance subsidiaries varies from 1 to 5 years depending

on the relative mix of domicile, percentages of product mix of insurance,

        reinsurance and retrocessional reinsurance, primary insurance, excess         insurance, reinsurance of direct, and reinsurance of reinsurance within         any given exposure category. Exposure portfolios written from a

non-U.S. domicile are assumed to have a greater time-lag than portfolios

        written from a U.S. domicile. Portfolios with a larger proportion of         reinsurance exposures are assumed to have a greater time-lag than         portfolios with a larger proportion of insurance exposures.   The assumptions above as to Ultimate Industry Asbestos and Environmental losses have not changed from the immediately preceding period. For our company as a whole, the average selected lag for asbestos has                                           62

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  increased slightly from 2.6 years to 2.8 years and the average selected lag for environmental has decreased slightly from 2.3 years to 2.2 years. The changes to the selected lags arose largely as a result of the changes in the relative sizes of the various underlying asbestos and environmental portfolios during 2012.  The following tables provide a summary of the impact of changes in industry ultimate losses, from the selected $65 billion for asbestos and $38.5 billion for environmental, and changes in the time-lag, from the selected averages of 2.8 years for asbestos and 2.2 years for environmental, for us behind industry development that it is assumed relates to our insurance and reinsurance companies. Please note that the table below demonstrates sensitivity to changes to key assumptions using methodologies selected for determining loss and allocated loss adjustment expenses, or ALAE, at December 31, 2012 and differs from the table on page 58, which demonstrates the range of outcomes produced by the various methodologies.                                                                       Asbestos   Sensitivity to Industry Asbestos Ultimate Loss Assumption     Loss Reserves                                                                 (in thousands                                                                of U.S. dollars)   Asbestos - $70 billion                                      $          636,465   Asbestos - $65 billion (selected)                                      534,923   Asbestos - $60 billion                                                 433,381                                                                            Environmental Sensitivity to Industry Environmental Ultimate Loss Assumption         Loss Reserves                                                                        (in thousands                                                                       of U.S. dollars) Environmental - $43.5 billion                                        $      

138,305

 Environmental - $38.5 billion (selected)                                    

93,720

 Environmental - $33.5 billion                                                    49,134                                                             Asbestos              Environmental Sensitivity to Time-Lag Assumption*                   Loss Reserves           Loss Reserves                                                                   (in thousands                                                                 of U.S. dollars) Selected average of 2.8 years asbestos, 2.2 years environmental                                  $       534,923         $        93,720 Increase all portfolio lags by six months                    595,683        

96,854

 Decrease all portfolio lags by six months                    468,392                  90,223    

* Using $65 billion/$38.5 billion Asbestos/Environmental Industry Ultimate Loss

assumptions.

   In the period from 2001-2009, industry publications generally indicated that the range of ultimate industry asbestos losses was estimated to be between approximately $55 billion and $65 billion. In late 2009, one commonly-referenced benchmark increased its estimate of ultimate industry asbestos losses from $65 billion to $75 billion. One of the reasons cited for this higher estimate was a shift of losses away from products liability claims to non-products claims. In considering the impact of this issue on our owned portfolios of asbestos exposures, it is important to understand how asbestos claims attach to policies issued by the insurance industry in general and to the policies issued by the companies owned by us in particular.  Historically, asbestos claims have been presented as "products liability" claims brought against manufacturers and distributors of asbestos-containing products. For a given manufacturer, distributor, or other entity involved in asbestos litigation, multiple claims are filed by numerous individuals. There is typically an allocation of the settlement costs for asbestos claims over time based on exposure to asbestos by the injured claimants. Many asbestos claims will aggregate within each individual policy period to exhaust the annual aggregate policy limits that exist within policies sold to cover products liability claims.  

Beginning in the mid-1990's, a trend began to emerge whereby certain policyholders began to assert that their asbestos claims should not fall within the "products liability" section of their policies and, therefore, should

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  not be subject to the aggregate limits of products liability claims. Instead, the policyholder would assert that each individual bodily injury claim should be treated as a separate occurrence under the "premises/operations" section of their policies. Under such presentation, individual claim or occurrence limits apply separately to each claim and there is no aggregate limit for the amount of "premises" or "non-products" claims within a particular policy.  Our exposure to asbestos losses arises largely from direct excess policies and assumed reinsurance policies written through the London market. With respect to direct excess policies, our companies typically participated on policies whereby liability would only attach in excess of primary and umbrella policy limits. As non-products asbestos losses are not aggregated and are generally confined to the limits of the primary and other lower layer insurance policies, we believe we have very little exposure to non-products asbestos losses through direct insurance policies issued by our subsidiary companies. To date, we have seen no material reporting of non-products asbestos claims on direct insurance policies. The trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our insurance entities have not received any material reporting of non-products claims to date and their direct insurance exposures are generally in excess of the layers of insurance impacted by non-products asbestos losses, we do not expect any material future liability in respect of non-products asbestos claims.  Losses with respect to assumed reinsurance exposures to non-products asbestos claims are unlikely to be aggregated and are generally confined to the limits of the primary and other lower layer insurance policies. There is limited ability for such claims to exceed retained levels. Our assumed reinsurance portfolio with respect to asbestos exposures is largely excess of loss in nature and, therefore, not especially subject to non-products asbestos liabilities. To date, we have seen no material reporting of non-products asbestos claims on assumed reinsurance policies.  As stated above, the trend of asbestos losses shifting from products to non-products is not a new phenomenon. As our assumed reinsurance entities have not received any material reporting of non-products claims to date and their assumed reinsurance exposures generally cover layers of insurance not impacted by non-products asbestos losses, management does not expect any material future liability in respect of non-products asbestos claims.  Other reasons cited for the 2009 increase in estimated industry ultimate asbestos losses include the ongoing uncertainty surrounding insurance coverage of asbestos claims and the ongoing reporting of significant numbers and values of malignant mesothelioma claims. We do not view these issues as new information, and therefore, any impact has already been factored into our actuarial reserving methodologies and does not create a need for any change in our assumptions.  

In late 2012, one commonly-referenced benchmark increased its estimate of ultimate industry asbestos losses from $75 billion to $85 billion. Little reasoning was given to explain the increase other than the fact that the industry has reported ultimate losses of $74 billion as of year-end 2011, and that the industry has been increasing its estimate of ultimate losses by approximately $2 billion per year over recent years. Based on the lack of reasoning presented, it is unclear to what extent the phenomena of asbestos losses presenting as "non-products" has influenced the most recent increase.

  It should be noted that our experience in recent years on its portfolio of asbestos exposures has not mirrored that of the industry. Over recent years, our ultimate loss estimates for asbestos have consistently decreased as a result of favourable commutation and policy buyback activity and a trend of favorable actual versus expected incurred loss emergence. Accordingly, we do not believe our recent loss development experience on our portfolio of asbestos exposures supports an increase to our loss reserve levels at this time.  One key measure of reserve strength for asbestos reserves is the three-year average paid survival ratio. This measure compares the asbestos carried-reserve amount with the average of the most recent three calendar years of asbestos loss payment activity. The most recent available information indicates that the insurance industry's                                           64 

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  asbestos reserve survival ratio at year-end 2011 is 9.7. Using an ultimate loss estimate of $85 billion (as opposed to $74 billion based on industry reserves carried at year-end 2011) produces a survival ratio of 14.4. Our carried-reserve survival ratio at year-end 2012 is 14.0. It should be noted that this is consistent with the industry three-year survival ratio when lagged by 2.8 years.  In summary, estimates of ultimate asbestos losses for the insurance industry have increased in recent years, however, our recent history of favorable settlements on commutations and policy buybacks and of lower incurred loss emergence relative to expectations does not support an increase to our asbestos loss reserve levels. Finally, our carried reserve level compares favorably with the industry carried reserve level - even under an $85 billion ultimate loss scenario - using the well-accepted three-year average paid survival ratio.  As the basis for our environmental reserving, we had, for a number of years and based on advice supplied by our independent consulting actuaries, selected an estimate of $35 billion ultimate industry environmental losses. Based on the most recent information available, industry reported incurred losses have now exceeded $35 billion. In addition, a notable industry publication has recently published a revised estimate of ultimate industry environmental losses of $42 billion. In light of these facts, in 2011, we increased our estimate of ultimate environmental industry losses from $35 billion to $38.5 billion as the basis for our environmental loss reserving. This change of assumption had no material impact on our consolidated financial statements. We continue to experience only moderate incurred loss development on our own portfolios of environmental exposures, and believe our carried reserve level for environmental exposures is appropriate based on the analysis conducted by both our internal and our external independent actuaries.  

Our current estimate of the time lag that relates to our insurance and reinsurance subsidiaries compared to the industry is considered reasonable given the analysis performed by our internal and external actuaries to date.

  Over time, additional information regarding such exposure characteristics may be developed for any given portfolio. This additional information could cause a shift in the lag assumed.  

All Other (Non-latent) Reserves

  For our "All Other" (non-latent) loss exposure, a range of traditional loss development extrapolation techniques is applied by our independent actuaries and us. These methods assume that cohorts, or groups, of losses from similar exposures will increase over time in a predictable manner. Historical paid, incurred, and outstanding loss development experience is examined for earlier years to make inferences about how later years' losses will develop. The application and consideration of multiple methods is consistent with the Actuarial Standards of Practice.  When determining which loss development extrapolation methods to apply to each company and each class of exposure within each company, we and our independent actuaries consider the nature of the exposure for each specific subsidiary and reserving segment and the available loss development data, as well as the limitations of that data. In cases where company-specific loss development information is not available or reliable, we and our independent actuaries select methods that do not rely on historical data (such as incremental or run-off methods) and consider industry loss development information published by industry sources such as the Reinsurance Association of America. In determining which methods to apply, we and our independent actuaries also consider cause of loss coding information when available.  A brief summary of the methods that are considered most frequently in analyzing non-latent exposures is provided below. This summary discusses the strengths and weaknesses of each method, as well as the data requirements for each method, all of which are considered when selecting which methods to apply for each reserve segment.  

1. Cumulative Reported and Paid Loss Development Methods. The Cumulative Reported (Case Incurred) Loss Development method relies on the assumption that, at any given state of maturity, ultimate losses can be

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  predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Historical "age-to-age" loss development factors (or LDFs) are calculated to measure the relative development of an accident year from one maturity point to the next. Age-to-age LDFs are then selected based on these historical factors. The selected age-to-age LDFs are used to project the ultimate losses. The Cumulative Paid Loss Development Method is mechanically identical to the Cumulative Reported Loss Development Method described above, but the paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using a cumulative loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple payments per claim, legal changes, or variations in a company's mix of business from year to year. Typically, the most appropriate circumstances in which to apply a cumulative loss development method are those in which the exposure is mature, full loss development data is available, and the historical observed loss development is relatively stable.  2. Incremental Reported and Paid Loss Development Methods.  Incremental incurred and paid analyses are performed in cases where cumulative data is not available. The concept of the incremental loss development methods is similar to the cumulative loss development methods described above, in that the pattern of historical paid or incurred losses is used to project the remaining future development. The difference between the cumulative and incremental methods is that the incremental methods rely on only incremental incurred or paid loss data from a given point in time forward, and do not require full loss history. These incremental loss development methods are therefore helpful when data limitations apply. While this versatility in the incremental methods is a strength, the methods are sensitive to fluctuations in loss development, so care must be taken in applying them.  3. IBNR-to-Case Outstanding Method.  This method requires the estimation of consistent cumulative paid and reported (case) incurred loss development patterns and age-to-ultimate LDFs, either from data that is specific to the segment being analyzed or from applicable benchmark or industry data. These patterns imply a specific expected relationship between IBNR, including both development on known claims (bulk reserve) and losses on true late reported claims, and reported case incurred losses. The IBNR-to-Case Outstanding method can be used in a variety of situations. It is appropriate for loss development experience that is mature and possesses a very high ratio of paid losses to reported case incurred losses. The method also permits an evaluation of the difference in maturity between the business being reviewed and benchmark development patterns. Depending on the relationship of paid to incurred losses, an estimate of the relative maturity of the business being reviewed can be made and a subsequent estimate of ultimate losses driven by the implied IBNR to case outstanding ratio at the appropriate maturity can be made. This method is also useful where loss development data is incomplete and only the case outstanding amounts are determined to be reliable. This method is less reliable in situations where relative case reserve adequacy has been changing over time.  

4. Bornhuetter-Ferguson Expected Loss Projection Reported and Paid Methods.

The

 Bornhuetter-Ferguson Expected Loss Projection Method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are based on initial selected ultimate loss ratios by year. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative incurred LDFs. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses. The calculations underlying the Bornhuetter-Ferguson Expected Loss Projection Method based on paid loss data are similar to the Bornhuetter-Ferguson calculations based on reported losses, with the exception that paid losses and unpaid percentages replace reported losses and unreported percentages. The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature years. For these immature years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is                                           66

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  assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort historical development of losses. Similar to the loss development methods, the Bornhuetter-Ferguson method may be applied to loss and ALAE on a combined or separate basis. The Bornhuetter-Ferguson method may not be appropriate in circumstances where the liabilities being analyzed are very mature, as it is not sensitive to the remaining amount of case reserves outstanding, or the actual development to date.  5. Reserve Run-off Method.  This method first projects the future values of case reserves for all underwriting years to future ages of development. This is done by selecting a run-off pattern of case reserves. The selected case run-off ratios are chosen based on the observed run-off ratios at each age of development. Once the ratios have been selected, they are used to project the future values of case reserves. A paid on reserve factor is selected in a similar way. The ratios of the observed amounts paid during each development period to the respective case reserves at the beginning of the periods are used to estimate how much will be paid on the case reserves during each development period. These paid on reserve factors are then applied to the case reserve amounts that were projected during the first phase of this method. A summation of the resulting paid amounts yields an estimate of the liability. The Reserve Run-off Method works well when the historical run-off patterns are reasonably stable and when case reserves ultimately show a decreasing trend. Another strength of this method is that it only requires case reserves at a given point in time and incremental paid and incurred losses after that point, meaning that it can be applied in cases where full loss history is not available. In cases of volatile data where there is a persistent increasing trend in case reserves, this method will fail to produce a reasonable estimate. In several cases, reliance upon this method was limited due to this weakness.  Our independent actuaries select the appropriate loss development extrapolation methods to apply to each company and each class of exposure, and then apply these methods to calculate an estimate of ultimate losses. Our management, which is responsible for the final estimate of ultimate losses, reviews the calculations of our independent actuaries, considers whether the appropriate method was applied, and adjusts the estimate of ultimate losses as it deems necessary. Historically, we have not deviated from the recommendations of our independent actuaries. Paid-to-date losses are then deducted from the estimate of ultimate losses to arrive at an estimated total loss reserve, and reported outstanding case reserves are then deducted from estimated total loss reserves to calculate the estimated IBNR reserve.  

Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities

  The change in our estimated total loss reserves for both latent and all other exposures compared to that of the previous period, less net losses paid during the period, is recorded as a reduction in net ultimate losses on our statement of earnings for the period. Our estimated total loss reserve at December 31, 2012 was determined by estimating the ultimate losses and deducting paid-to-date losses. The estimated ultimate losses, for both latent and all other (non-latent) liabilities, were determined by the amount of advised case reserves and the application of the actuarial methodologies described above to estimate IBNR reserves. Future changes in our estimates of ultimate losses are likely to have a significant impact on future operating results. Our operating objective is to commute our loss exposures and manage non-commuted loss development in a disciplined manner such that future incurred loss development will be less than expected. A combination of future commutations and better-than-expected incurred loss development of non-commuted exposures could improve the trend of loss development and, after the application of actuarial methodologies to the improved trend, reduce the December 31, 2012 estimates of ultimate losses with a positive impact on our future results. However, it is not possible to project future commutation settlements or whether incurred loss development will be better than expected, and it is possible that ultimate loss reserves could increase based on the factors discussed herein.  

Quarterly Reserve Reviews

In addition to an in-depth annual review, we also perform quarterly reserve reviews. This is done by examining quarterly paid and incurred loss development to determine whether it is consistent with reserves

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  established during the preceding annual reserve review and with expected development. Loss development is reviewed separately for each major exposure type (e.g., asbestos, environmental, etc.), for each of our relevant subsidiaries, and for large "wholesale" commutation settlements versus "routine" paid and advised losses. This process is undertaken to determine whether loss development experience during a quarter warrants any change to held reserves.  Loss development is examined separately by exposure type because different exposures develop differently over time. For example, the expected reporting and payout of losses for a given amount of asbestos reserves can be expected to take place over a different time frame and in a different quarterly pattern from the same amount of environmental reserves.  In addition, loss development is examined separately for each of our relevant subsidiaries. Companies can differ in their exposure profile due to the mix of insurance versus reinsurance, the mix of primary versus excess insurance, the underwriting years of participation and other criteria. These differing profiles lead to different expectations for quarterly and annual loss development by company.  Our quarterly paid and incurred loss development is often driven by large, "wholesale" settlements - such as commutations and policy buy-backs - which settle many individual claims in a single transaction. This allows for monitoring of the potential profitability of large settlements, which, in turn, can provide information about the adequacy of reserves on remaining exposures that have not yet been settled. For example, if it were found that large settlements were consistently leading to large negative, or favorable, incurred losses upon settlement, it might be an indication that reserves on remaining exposures are redundant. Conversely, if it were found that large settlements were consistently leading to large positive, or adverse, incurred losses upon settlement, it might be an indication - particularly if the size of the losses were increasing - that certain loss reserves on remaining exposures are deficient. Moreover, removing the loss development resulting from large settlements allows for a review of loss development related only to those contracts that remain exposed to losses. Were this not done, it is possible that savings on large wholesale settlements could mask significant underlying development on remaining exposures.  Once the data has been analyzed as described above, an in-depth review is performed on classes of exposure with significant loss development. Discussions are held with appropriate personnel, including individual company managers, claims handlers and attorneys, to better understand the causes. If it were determined that development differs significantly from expectations, reserves would be adjusted.  Quarterly loss development is expected to be fairly erratic for the types of exposure insured and reinsured by us. Several quarters of low incurred loss development can be followed by spikes of relatively large incurred losses. This is characteristic of latent claims and other insurance losses that are reported and settled many years after the inception of the policy. Given the high degree of statistical uncertainty, and potential volatility, it would be unusual to adjust reserves on the basis of one, or even several, quarters of loss development activity. As a result, unless the incurred loss activity in any one quarter is of such significance that management is able to quantify the impact on the ultimate liability for loss and loss adjustment expenses, reductions or increases in loss and loss adjustment expense liabilities are carried out in the fourth quarter based on the annual reserve review described above.  As described above, our management regularly reviews and updates reserve estimates using the most current information available and employing various actuarial methods. Adjustments resulting from changes in our estimates are recorded in the period when such adjustments are determined. The ultimate liability for loss and loss adjustment expenses is likely to differ from the original estimate due to a number of factors, primarily consisting of the overall claims activity occurring during any period, including the completion of commutations of assumed liabilities and ceded reinsurance receivables, policy buy-backs and general incurred claims activity.                                           68

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Provisions for Unallocated Loss Adjustment Expense Liabilities

  Provisions for unallocated loss adjustment expense liabilities are estimated by management by determining the future annual costs to be incurred by us, comprising staff costs, consultancy and professional fees and overheads, in managing the run-off of claims liabilities for each of our insurance and reinsurance entities and is increased with outstanding losses and loss expenses. The provision is reviewed quarterly and adjusted in accordance with the related costs incurred each period.  

Reinsurance Balances Recoverable

  Our acquired reinsurance subsidiaries, prior to acquisition by us, used retrocessional agreements to reduce their exposure to the risk of insurance and reinsurance they assumed. Loss reserves represent total gross losses, and reinsurance receivables represent anticipated recoveries of a portion of those unpaid losses as well as amounts receivable from reinsurers with respect to claims that have already been paid. While reinsurance arrangements are designed to limit losses and to permit recovery of a portion of direct unpaid losses, reinsurance does not relieve us of our liabilities to our insureds or reinsureds. Therefore, we evaluate and monitor concentration of credit risk among our reinsurers, including companies that are insolvent, in run-off or facing financial difficulties. Provisions are made for amounts considered potentially uncollectible.  To estimate the provision for uncollectible reinsurance recoverable, the reinsurance recoverable is first allocated to applicable reinsurers. As part of this process, ceded IBNR is allocated by reinsurer. We use a detailed analysis to estimate uncollectible reinsurance. The primary components of the analysis are reinsurance recoverable balances by reinsurer and bad debt provisions applied to these balances to determine the portion of a reinsurer's balance deemed to be uncollectible. These provisions require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer (in order to determine its ability to settle the reinsurance balances) as well as other key considerations and assumptions, such as claims and coverage issues.  

Valuation of Investments

  We invest in a trading portfolio of fixed maturity investments and equities and an available-for-sale portfolio of fixed maturity investments. We record both the trading and available-for-sale portfolios at fair value on our balance sheet. For our trading portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in net earnings. For our available-for-sale portfolio, the unrealized gain or loss (other than credit losses) is recorded in accumulated other comprehensive income in the shareholders' equity section of our consolidated balance sheet.  

Our other investments comprise investments in various private equity, fixed income, fixed income hedge, equity and real estate debt funds, all of which are recorded at fair value.

  We measure fair value in accordance with Accounting Standards Codification (or ASC) 820, Fair Value Measurements. The guidance dictates a framework for measuring fair value and a fair value hierarchy based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:   

• Level 1 - Quoted prices for identical instruments in active markets.

• Level 2 - Quoted prices for similar instruments in active markets; quoted

prices for identical or similar instruments in markets that are not

active; and model-derived valuations in which all significant inputs and

         significant value drivers are observable in active markets.    

• Level 3 - Model-derived valuations in which one or more significant inputs

         or significant value drivers are unobservable.                                            69 

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  When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3).  

The use of valuation techniques may require a significant amount of judgment. During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable.

Fixed Maturity Investments

  Fixed maturity investments are subject to fluctuations in fair value due to changes in interest rates, changes in issuer specific circumstances such as credit rating and changes in industry specific circumstances such as movements in credit spreads based on the market's perception of industry risks. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. At maturity, absent any credit loss, fixed maturity investments amortized cost will equal their fair value and no realized gain or loss will be recognized in income. If, due to an unforeseen change in loss payment patterns, we need to sell any available-for-sale investments before maturity, we could realize significant gains or losses in any period, which could result in a meaningful effect on reported net income for such period.  We perform regular reviews of our available-for-sale fixed maturities portfolios and utilize a process that considers numerous indicators in order to identify investments that are showing signs of potential other than temporary impairment losses. These indicators include the length of time and extent of the unrealized loss, any specific adverse conditions, historic and implied volatility of the security, failure of the issuer of the security to make scheduled interest payments, significant rating changes and recoveries or additional declines in fair value subsequent to the balance sheet date. The consideration of these indicators and the estimation of credit losses involve significant management judgment.  Any other-than-temporary impairment loss, or OTTI, related to a credit loss would be recognized in earnings, and the amount of the OTTI related to other factors (e.g. interest rates, market conditions, etc.) is recorded as a component of other comprehensive income. If no credit loss exists but either we have the intent to sell the fixed maturity investment or it is more likely than not that we will be required to sell the fixed maturity investment before its anticipated recovery, then the entire unrealized loss is recognized in earnings.  

For the years ended December 31, 2012, 2011 and 2010, we did not recognize any other than temporary impairment charges through earnings.

  Our fixed maturity portfolio is managed by our Chief Investment Officer and outside investment advisors with oversight from our Investment Committee. Fair value prices for all investments in the fixed maturity portfolios are independently provided by the investment custodian, investment accounting service provider and investment managers, each of which utilize internationally recognized independent pricing services. Interactive Data Corporation is, however, the main pricing service utilized to estimate the fair value measurements for our fixed maturity investments. We record the unadjusted price provided by the investment custodian, investment accounting service provider or the investment manager and validate this price through a process that includes, but is not limited to: (i) comparison of prices against alternative pricing sources; (ii) quantitative analysis (e.g. comparing the quarterly return for each managed portfolio to its target benchmark); (iii) evaluation of methodologies used by external parties to estimate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to our knowledge of the current investment market. Our internal price validation procedures and review of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.  The independent pricing services used by the investment custodian, investment accounting service provider and investment managers obtain actual transaction prices for investments that have quoted prices in active                                           70

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  markets. For determining the fair value of investments that are not actively traded, in general, pricing services use "matrix pricing" in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, using observable data, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for investments such as mortgage-backed and asset-backed investments.  

Other Investments

  Our other investments are comprised of private equity, fixed income, fixed income hedge, equity and real estate debt funds. Investments in the funds are carried at their net asset values, which approximate fair value. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda. The change in fair value is included in net realized and unrealized gains on investments and recognized in net earnings. These investments are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator.  We have ongoing due diligence processes with respect to funds in which we invest and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is warranted. Certain funds do not provide full transparency of their underlying holdings; however, we obtain the audited financial statements for funds annually, and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value (and not use the permitted practical expedient) on an investment by investment basis. These adjustments may involve significant management judgment.  For our investments in private equity funds, we measure fair value by obtaining the most recently provided capital statement from the external fund manager or third-party administrator. The funds calculate net asset value on a fair value basis. Due to a lag in the valuations reported by the managers, we record changes in the investment value with up to a three-month lag. For all publicly-traded companies within these funds, we adjust the reported net asset value based on the latest share price as of our reporting date. We have classified our investments in private equity funds as Level 3 investments because they reflect our own judgment about the assumptions that market participants might use.  The fixed income funds and equity fund in which we invest have been classified as Level 2 investments because their fair value is estimated using the net asset value provided regularly and because the fixed income funds and equity fund are highly liquid.  

For our investments in fixed income hedge funds, we measure fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The investments in the funds are classified as Level 3.

  The real estate debt fund in which we invest has been classified as a Level 3 investment because its fair value is estimated using the most recent published net asset value.  

Our remaining other investments are valued based on the latest available capital statements and have been classified as Level 3.

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  Certain funds included in other investments are subject to a lock-up period. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem the investment. Funds that do provide for periodic redemptions may, depending on the funds' governing documents, have the ability to deny or delay a redemption request, which is called a "gate." The fund may restrict redemptions because the aggregate amount of redemption requests as of a particular date exceeds a specified level. The gate is a method for executing an orderly redemption process that allows for redemption requests to be executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion to be settled in cash sometime after the redemption date.  Certain funds included in other investments may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a "side-pocket", whereby the illiquid security is assigned to a separate memorandum capital account or designated account. Typically, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or is otherwise deemed liquid by the fund, may investors redeem their interest in the side-pocket.  

As at December 31, 2012, none of our funds included in other investments were subject to gates or had side-pockets.

  A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur.                                             72 

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Results of Operations

The following table sets forth our selected consolidated statements of earnings data for each of the periods indicated:

                                                               Years Ended December 31,                                                      2012             2011             2010                                                          (in thousands of U.S. dollars) INCOME Consulting fees                                   $    8,570       $   17,858       $   23,015 Net investment income                                 77,760           68,676           81,261 Net realized and unrealized gains                     73,612            9,214           31,782 Gain on bargain purchase                                   -           13,105                -                                                       159,942          108,853          136,058  EXPENSES Net reduction in ultimate loss and loss adjustment expense liabilities: Reduction in estimates of net ultimate losses       (221,927 )       (250,216 )       (278,065 ) Reduction in provisions for bad debt                  (3,111 )        (42,822 )        (49,556 ) Reduction in provisions for unallocated loss adjustment expense liabilities                       (39,298 )        (45,102 )        (39,651 ) Amortization of fair value adjustments                22,572           42,693           55,438                                                      (241,764 )       (295,447 )       (311,834 ) Salaries and benefits                                100,473           89,846           86,677 General and administrative expenses                   56,592           71,810           59,201 Interest expense                                       8,426            8,529           10,253 Net foreign exchange losses (gains)                      406              373             (398 )                                                       (75,867 )       (124,889 )       (156,101 )  Earnings before income taxes and share of net earnings of equity method investee                   235,809          233,742          292,159 Income taxes                                         (44,290 )        (25,284 )        (87,132 ) Share of net earnings of equity method investee                                                   -                -           10,704  NET EARNINGS                                         191,519          208,458          215,731 Less: Net earnings attributable to noncontrolling interest                              (23,502 )        

(54,765 ) (41,645 )

  NET EARNINGS ATTRIBUTABLE TO ENSTAR GROUP LIMITED                                           $  168,017       $  153,693       $  174,086                                             73 

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  The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report. Some of the information contained in this discussion and analysis or included elsewhere in this annual report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Risk Factors," "Cautionary Statement Regarding Forward-Looking Statements" and elsewhere in this annual report.  

Comparison of Years Ended December 31, 2012 and 2011

  We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $191.5 million and approximately $208.5 million for the years ended December 31, 2012 and 2011, respectively. The decrease in earnings of approximately $17.0 million was attributable primarily to the following:        (i)  an increase in net realized and unrealized gains of $64.4 million due          primarily to: (a) mark-to-market changes in the market value of our          equity securities; (b) increases in realized gains on our fixed          maturities; and (c) increased returns from our other investments;         (ii) a decrease in general and administrative expenses of $15.2 million due          principally to decreased legal fees and settlement costs related to          certain litigation settled in 2011; and         (iii) an increase in net investment income of $9.1 million primarily as a           result of higher average cash and fixed maturities balances for 2012 as           a result of the Clarendon National Insurance Company acquisition, which

was partially offset by a decrease in yields due to declining yields in

          the global fixed maturities markets; partially offset by         (iv) a lower net reduction in ultimate loss and loss adjustment expense          liabilities of $53.7 million;         (v)  an increase in income taxes of $19.0 million due to increased tax          liabilities recorded on the results of our taxable subsidiaries;         (vi) a gain on bargain purchase of $13.1 million in 2011, which arose in          relation to our acquisition of Laguna Life Limited (as compared to no          gain on bargain purchase in 2012);         (vii) an increase in salaries and benefits costs of $10.6 million due           primarily to an increase in salary costs for our U.S. operations along           with an increase in our discretionary bonus plan as a result of an           increase in net earnings for the year; and         (viii) a decrease in consulting fee income of $9.3 million due to lower            revenue from incentive-based fee arrangements.   Noncontrolling interest in earnings decreased by $31.3 million to $23.5 million primarily as a result of lower earnings in those companies in which there are noncontrolling interests. Net earnings attributable to Enstar Group Limited increased from $153.7 million for the year ended December 31, 2011 to $168.0 million for the year ended December 31, 2012.  

Comparison of Years Ended December 31, 2011 and 2010

  We reported consolidated net earnings, before net earnings attributable to noncontrolling interest, of approximately $208.5 million and approximately $215.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in earnings of approximately $7.2 million was attributable primarily to the following:        (i)  a decrease in net investment income of $12.6 million primarily as a

result of a decrease, in 2011, in net investment income due primarily to

         lower yields earned on our fixed maturity investments;                                            74 

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(ii) a decrease in net realized and unrealized gains of $22.6 million due

primarily to a decrease in our realized and unrealized gains on our other

         investments along with a decrease in net realized gains on our fixed          maturities and equities as a result of conditions in the U.S. equity          markets;    

(iii) a lower net reduction in ultimate loss and loss adjustment expense

          liabilities of $16.4 million;    

(iv) a decrease in consulting fee income of $5.2 million due to lower revenue

         from incentive-based fee arrangements;    

(v) an increase in salaries and benefits costs of $3.2 million due primarily

         to our increased overall headcount from 335 at December 31, 2010 to 412          at December 31, 2011, which was offset by a reduction in salary costs          related to our discretionary bonus plan as a result of decreased net          earnings for the year;    

(vi) an increase in general and administrative expenses of $12.6 million due

primarily to an increase in loan structure fees and letter of credit fees

         that were paid in 2011, along with an overall increase in other          professional fees due primarily to legal fees and settlement costs          associated with certain litigation; and    

(vii) a decrease of $10.7 million in our share of net earnings of our equity

          method investee; partially offset by    

(viii) a gain on bargain purchase of $13.1 million in 2011, which arose in

           relation to our acquisition of Laguna Life Limited;         (ix) a decrease in income taxes of $61.8 million due to decreased tax

liabilities recorded on the results of our taxable subsidiaries and an

additional tax liability of $30.3 million provided for in 2010 arising in

         our Australian subsidiary from the formation of an Australian tax          consolidated group that did not recur in 2011; and    

(x) a decrease in interest expense of $1.7 million due primarily to lower

interest rates on the loan facilities outstanding during 2011.

   We recorded noncontrolling interest in earnings of $54.8 million and $41.6 million for the years ended December 31, 2011 and 2010, respectively. Net earnings attributable to Enstar Group Limited decreased from $174.1 million for the year ended December 31, 2010 to $153.7 million for the year ended December 31, 2011.  Consulting Fees:                                            Years Ended December 31,                       2012       Variance         2011       Variance         2010                                      (in thousands of U.S. dollars)              Total   $ 8,570     $  (9,288 )    $ 17,858     $  (5,157 )    $ 23,015   

Comparison of Years Ended December 31, 2012 and 2011

  Our consulting companies earned fees of approximately $8.6 million and $17.9 million for the years ended December 31, 2012 and 2011, respectively. The decrease in consulting fees of $9.3 million related to the decrease in management fees earned from incentive-based engagements. Consulting fee income as a percentage of net earnings has declined in recent periods, and we would expect it to remain at or around current levels in future periods, excluding the impact of any one-time incentive based fees that we might receive. While we intend to continue to provide management and consultancy services, claims inspection services and reinsurance collection services to third-party clients in limited circumstances, our core focus continues to be acquiring and managing insurance and reinsurance companies and portfolios of business in run-off.                                           75

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Comparison of Years Ended December 31, 2011 and 2010

Our consulting companies earned fees of approximately $17.9 million and $23.0 million for the years ended December 31, 2011 and 2010, respectively. The decrease in consulting fees of $5.2 million related to the decrease in management fees earned from incentive-based engagements.

Net Investment Income and Net Realized and Unrealized Gains:

                                                                 Years Ended December 31,                              Net Investment Income                                         Net Realized and Unrealized Gains           2012        Variance        2011       Variance         2010         2012       Variance       2011       Variance         2010                                                           (in thousands of U.S. dollars) Total   $ 77,760     $    9,084     $ 68,676     $ (12,585 )    $ 81,261     $ 73,612     $  64,398     $ 9,214     $ (22,568 )    $ 31,782    

Comparison of Years Ended December 31, 2012 and 2011

  Net investment income for the year ended December 31, 2012</chron> increased by $9.1 million to $77.8 million, as compared to $68.7 million for the year ended December 31, 2011. The increase was primarily a result of higher than average cash and fixed maturities for 2012 as a result of the 2011 acquisition of Clarendon National Insurance Company, or Clarendon. In 2012, we had a full year of net investment income from Clarendon as opposed to net investment income for approximately six months in 2011 from the date of acquisition. Lower absolute yields obtained on cash and fixed maturities due to declining yields in global fixed maturities markets offset part of this increase.  Net realized and unrealized gains for the years ended December 31, 2012 and 2011 were $73.6 million and $9.2 million, respectively. The increase of $64.4 million was primarily attributable to a combination of the following:    

(i) an increase of $12.8 million in net realized gains on our fixed maturities

        and short-term investments mostly due to increased trading in those asset         classes;    

(ii) an increase of $19.6 million in unrealized gains on trading securities as

         a result of increases in the value of our investments in equities and          fixed maturities in line with increases in the global markets; and         (iii) an increase of $30.2 million in returns from other investments due to           increases in global equity and fixed income markets, combined with           greater amounts invested in those asset classes in 2012.   The average annualized return on the cash and fixed maturities (inclusive of net realized and unrealized gains, but excluding net investment income and net realized and unrealized gains related to our other investments and equities) for the year ended December 31, 2012 was 2.3% as compared to the average return of 1.7% for the year ended December 31, 2011. The average credit rating of our fixed maturities at December 31, 2012 and December 31, 2011 was AA-. The average annualized return on our other investments and equities (inclusive of net realized and unrealized gains) for the year ended December 31, 2012 was 11.8% as compared to the average return of 1.7% for the year ended December 31, 2011.  

Comparison of Years Ended December 31, 2011 and 2010

  Net investment income for the year ended December 31, 2011 decreased by $12.6 million to $68.7 million, as compared to $81.3 million for the year ended December 31, 2010. The decrease was primarily attributable to a combination of the following:        (i) a decrease of $7.1 million in interest income from cash and fixed         maturities (net of amortization of bond premiums and discounts) as a

result of lower yields earned driven by lower interest rates in developed

        economies, primarily the United States;                                            76 

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  Table of Contents   (ii) a decrease of $2.1 million in our income from other investments;       (iii) a decrease of $2.0 million in our other income; and    

(iv) an increase of $1.8 million in our investment expenses due to the hiring

of additional third-party investment managers in 2011.

   The average annualized return on the cash and fixed maturities (inclusive of net realized and unrealized gains, but excluding net investment income and net realized and unrealized gains related to our other investments and equities) for the year ended December 31, 2011 was 1.7% as compared to the average return of 2.2% for the year ended December 31, 2010. The average annualized return on our other investments (inclusive of net realized and unrealized gains) for the year ended December 31, 2011 was 1.7% as compared to the average return of 14.7% for the year ended December 31, 2010.  Net realized and unrealized gains for the years ended December 31, 2011 and 2010 were $9.2 million and $31.8 million, respectively. The decrease of $22.6 million was primarily attributable to a combination of the following:    

(i) a decrease of $17.5 million in realized and unrealized gains on our other

investments, largely related to net losses recorded on our private equity

        investments in 2011 (whereas net gains were recorded in 2010);    

(ii) a decrease of $3.8 million in net realized gains on our fixed maturities

and equities mostly related to lower realized gains from our equities as

         a result of conditions in the U.S. equity markets; and    

(iii) a decrease of $1.3 million in the change of net unrealized gains on our

fixed maturities and equities as a result of the lower performance of

the global markets in 2011 versus 2010.

   The average credit rating of our fixed maturities at December 31, 2011 was AA- (2010: AA-). During 2011, the rating agency Standard & Poors downgraded the U.S. sovereign debt from AAA to AA+. This, combined with the assets we acquired upon the acquisition of Clarendon, which had a lower proportion of investments with AAA credit ratings, has resulted in us having a lower percentage of AAA-rated investments than we had as at December 31, 2010.  

Gain on Bargain Purchase:

                                         Years Ended December 31,                         2012      Variance         2011       Variance      2010                                      (in thousands of U.S. dollars)                 Total   $   -     $ (13,105 )    $ 13,105     $  13,105     $   -    Gain on bargain purchase of $13.1 million was recorded for the year ended December 31, 2011. The gain on bargain purchase was earned in connection with our acquisition of Laguna Life Limited, or Laguna, and represents the excess of the cumulative fair value of net assets acquired of $34.3 million over the cost of $21.2 million. This excess was, in accordance with the provisions of the Business Combinations topic of the FASB ASC, recognized as income for the year ended December 31, 2011. The gain on bargain purchase arose mainly as a result of our reassessment, upon acquisition, of the total required estimated costs to manage the business to expiry. Our assessment of costs was lower than the acquired costs recorded by the vendor in the financial statements of Laguna.                                           77 

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Net Reduction in Ultimate Loss and Loss Adjustment Expense Liabilities:

The following table shows the components of the movement in the net reduction in ultimate loss and loss adjustment expense liabilities for the years ended December 31, 2012, 2011 and 2010:

                                                            Years Ended December 31,                                   2012          Variance           2011          Variance           2010                                                       (in thousands of U.S. dollars) Net losses paid                $ (310,695 )     $ (26,084 )     $ (284,611 )     $  10,385       $ (294,996 ) Net reduction in case and LAE reserves                      265,222         (44,814 )        310,036         (26,105 )        336,141 Net reduction in IBNR reserves                          267,400          42,609          224,791  

(12,129 ) 236,920

  Reduction in estimates of net ultimate losses               221,927         (28,289 )        250,216         (27,849 )        278,065 Reduction in provisions for bad debt                        3,111         (39,711 )         42,822          (6,734 )         49,556 Reduction in provisions for unallocated loss adjustment expense liabilities                        39,298          (5,804 )         45,102           5,451           39,651 Amortization of fair value adjustments                       (22,572 )        20,121          (42,693 

) 12,745 (55,438 )

  Net reduction in ultimate loss and loss adjustment expense liabilities            $  241,764       $ (53,683 )     $  295,447       $ (16,387 )     $  311,834    Net reduction in case and LAE reserves comprises the movement during the year in specific case reserve liabilities as a result of claims settlements or changes advised to us by our policyholders and attorneys, less changes in case reserves recoverable advised by us to our reinsurers as a result of the settlement or movement of assumed claims. Net reduction in IBNR reserves represents the change in our actuarial estimates of losses incurred but not reported, less amounts recoverable.  

Comparison of Years Ended December 31, 2012 and 2011

  The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2012 of $241.8 million was attributable to a reduction in estimates of net ultimate losses of $221.9 million, a reduction in aggregate provisions for bad debt of $3.1 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $39.3 million, relating to 2012 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $22.6 million.  The reduction in estimates of net ultimate losses of $221.9 million comprised net incurred loss development of $45.5 million and reductions in net IBNR reserves of $267.4 million. During the three months ended December 31, 2012, one of our insurance entities, following an exposure-based review of all advised claims, allocated $52.4 million of net IBNR reserves to specific net case and LAE reserves. Excluding this allocation, net incurred loss development for the year ended December 31, 2012 was a favorable $6.9 million and reductions in net IBNR reserves amounted to $215.0 million. The decrease in the aggregate estimate of net IBNR reserves of $215.0 million, excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves (compared to $224.8 million during the year ended December 31, 2011), was comprised of $36.4 million relating to asbestos liabilities (compared to $57.9 million in 2011), $2.6 million relating to environmental liabilities (compared to $2.8 million in 2011), $96.3 million relating to general casualty liabilities (compared to $91.6 million in 2011) and $79.7 million relating to all other remaining liabilities (compared to $72.5 million in 2011).                                           78

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  The aggregate reduction in net IBNR reserves of $215.0 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of our actuarial methodologies to revised historical loss development data, following 101 commutations, to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures. The prior period estimate of aggregate net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2012, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The net incurred favorable loss development, excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves, of $6.9 million, resulting from settlement of net advised case and LAE reserves of $317.6 million for net paid losses of $310.7 million, related to the settlement of non-commuted losses in the year and 101 commutations of assumed and ceded exposures. Net incurred liabilities settled by way of commutation during the year ended December 31, 2012 amounted to $26.6 million (comprising $163.1 million of assumed incurred liabilities partially offset by $136.5 million of ceded incurred reinsurance recoverables) compared to the net aggregate reduction in advised case reserves during the same period of $317.6 million (excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves).  Commutations provide an opportunity for us to exit exposures to entire policies with insureds and reinsureds at a discount to the previous estimated ultimate liability. As a result of exiting all exposures to such policies, all advised case reserves and net IBNR reserves relating to that insured or reinsured are eliminated. This often results in a net gain irrespective of whether the settlement exceeds the advised case reserves. We adopt a disciplined approach to the review and settlement of non-commuted claims through claims adjusting and the inspection of underlying policyholder records such that settlements of assumed exposures may often be achieved below the level of the originally advised loss, and settlements of ceded receivables may often be achieved at levels above carried balances.  Of the 101 commutations completed, three related to our top ten insured and/or reinsured exposures, and one related to our top ten ceded reinsurance assets, all four of which commutations were completed in the three months ended June 30, 2012. The remaining 97 commutations, of which approximately 33% were completed during the three months ended December 31, 2012, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2012, including commutations, and the actuarial estimation of net IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2012 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in net IBNR reserves of $215.0 million (excluding the allocation of $52.4 million from net IBNR reserves to specific net case and LAE reserves) in 2012.  The reduction in aggregate provisions for bad debt of $3.1 million was a result of the collection of certain reinsurance recoverables against which bad debt provisions had been provided in earlier periods.  

Comparison of Years Ended December 31, 2011 and 2010

  The net reduction in ultimate loss and loss adjustment expense liabilities for the year ended December 31, 2011 of $295.4 million was attributable to a reduction in estimates of net ultimate losses of $250.2 million, a reduction in aggregate provisions for bad debt of $42.8 million and a reduction in estimates of unallocated loss adjustment expense liabilities of $45.1 million, relating to 2011 run-off activity, partially offset by the amortization, over the estimated payout period, of fair value adjustments relating to companies acquired amounting to $42.7 million.  The reduction in estimates of net ultimate losses of $250.2 million comprised net incurred favorable loss development of $25.4 million and reductions in net IBNR reserves of $224.8 million. The aggregate reduction in net                                           79

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  IBNR reserves of $224.8 million was a result of the application, on a basis consistent with the assumptions applied in the prior period, of our actuarial methodologies to revised historical loss development data, following 113 commutations (including three commutations completed shortly after December 31, 2011), to estimate loss reserves required to cover liabilities for unpaid losses and loss adjustment expenses relating to non-commuted exposures.  The prior period estimate of aggregate net IBNR reserves was reduced as a result of the combined impact on all classes of business of loss development activity during 2011, including commutations and the favorable trend of loss development related to non-commuted policies compared to prior forecasts. The lower reduction in asbestos IBNR reserves during 2010 was primarily due to reduced commutations of asbestos related exposures compared to the prior year. Total net loss reserves acquired from January 1, 2008 to December 31, 2010 amounted to $3,197.3 million, of which $2,634.5 million, or 82.4%, related to all other losses. This increase in all other loss reserves provided the basis for a greater reduction in all other IBNR reserves. The net incurred favorable loss development of $25.4 million, resulting from settlement of net advised case and LAE reserves of $310.0 million for net paid losses of $284.6 million, related to the settlement of non-commuted losses in the year and approximately 110 commutations of assumed and ceded exposures, excluding the three commutations completed subsequent to December 31, 2011. Net incurred liabilities settled by way of commutation during the year ended December 31, 2011 (excluding the three commutations completed subsequent to December 31, 2011) amounted to $71.5 million compared to the net reduction in advised case reserves during the same period of $310.0 million.  Of the 113 commutations completed during 2011, nine related to our top ten insured and/or reinsured exposures and two related to our top ten ceded reinsurance assets, including three commutations completed shortly after December 31, 2011 whereby the related reduction in net IBNR reserves was recorded in the reduction in net ultimate losses for the year. The remaining 102 commutations, of which approximately 46% were completed during the three months ended December 31, 2011, were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships. The combination of the claims settlement activity in 2011, including commutations, and the actuarial estimation of net IBNR reserves required for the remaining non-commuted exposures (which took into account the favorable trend of loss development in 2011 related to such exposures compared to prior forecasts), resulted in our management concluding that the loss development activity that occurred subsequent to the prior reporting period provided sufficient new information to warrant a reduction in net IBNR reserves of $224.8 million in 2011.  The reduction in aggregate provisions for bad debt of $42.8 million was a result of the collection, primarily during the three months ended December 31, 2011, of certain reinsurance receivables against which bad debt provisions had been provided in earlier periods.                                           80 

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  The table below provides a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses for the years ended December 31, 2012, 2011, and 2010. Losses incurred and paid are reflected net of reinsurance recoverables.                                                              Years Ended December 31,                                                  2012               2011               2010                                                        (in thousands of U.S. dollars) Balance as of January 1                       $ 4,282,916        $ 3,291,275        $ 2,479,136 Less: total reinsurance reserves recoverable                                     1,383,003            525,440            347,728                                                  2,899,913          2,765,835          2,131,408 Effect of exchange rate movement                   15,004             (9,170 )           (3,836 ) Net reduction in ultimate loss and loss adjustment expense liabilities                   (241,764 )         (295,447 )         (311,834 ) Net losses paid                                  (310,695 )         (284,611 )         (294,996 ) Acquired on purchase of subsidiaries                    -            610,485            459,362 Assumed business                                  422,476            112,821            785,731  Net balance as at December 31                   2,784,934          2,899,913          2,765,835 Plus: total reinsurance reserves recoverable                                       876,220          1,383,003            525,440  Balance as at December 31                     $ 3,661,154        $ 4,282,916        $ 3,291,275    Salaries and Benefits:                                            Years Ended December 31,                       2012        Variance         2011       Variance         2010                                      (in thousands of U.S. dollars)             Total   $ 100,473     $ (10,627 )    $ 89,846     $  (3,169 )    $ 86,677   

Comparison of Years Ended December 31, 2012 and 2011

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $100.5 million and $89.8 million for the years ended December 31, 2012 and 2011, respectively.

The principal changes in salaries and benefits were:

(i) an increase in the discretionary bonus provision of $3.0 million due to

        the increase in net earnings for the year ended December 31, 2012 as         compared to 2011. Expenses relating to our discretionary bonus plan will         be variable and are dependent on our overall profitability;    

(ii) a lower expense for 2011 attributable to the release back to earnings of

approximately $4.0 million related to the unallocated portion of the 2010

         year-end bonus accrual provision; and    

(iii) increased staff costs due to an increase in our average headcount from

378 in 2011 to 392 in 2012, attributable to staff acquired on completion

of the Clarendon acquisition in July 2011, partially offset by

reductions in headcount in both our U.K. and Australian subsidiaries.

   For 2013, we expect costs related to salaries and benefits to increase over 2012 levels due primarily to the expected increase in headcount within our U.S. operations as a result of the recently completed SeaBright acquisition and the pending acquisition of the HSBC Insurance Companies, which is expected to close by the end of the first quarter of 2013.                                           81

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Comparison of Years Ended December 31, 2011 and 2010

Salaries and benefits, which include expenses relating to our discretionary bonus and employee share plans, were $89.8 million and $86.7 million for the years ended December 31, 2011 and 2010, respectively.

The principal changes in salaries and benefits were:

(i) increased staff costs due to an increase in staff numbers from 335 for the

year ended December 31, 2010 to 415 for the year ended December 31, 2011

attributable to staff acquired on completion of the Clarendon Acquisition

        in July 2011;    

(ii) increased U.S. dollar costs of our U.K.-based staff following an increase

in the average British pound exchange rate from approximately 1.5458 for

the year ended December 31, 2010 to 1.6041 for the year ended December

31, 2011. Approximately 61% and 67% of the average staff numbers for the

years ended December 31, 2011 and 2010, respectively, had their salaries

         paid in British pounds; partially offset by    

(iii) the reduction in the discretionary bonus accrual of $8.1 million due to

the release back to earnings in 2011 of approximately $4.0 million

relating to the unallocated portion of the 2010 year-end bonus accrual

provision and the reduction in net earnings for the year ended December

31, 2011 as compared to 2010.

General and Administrative Expenses:

                                         Years Ended December 31,                        2012       Variance        2011       Variance         2010                                      (in thousands of U.S. dollars)              Total   $ 56,592     $  15,218     $ 71,810     $ (12,609 )    $ 59,201   

Comparison of Years Ended December 31, 2012 and 2011

General and administrative expenses decreased by $15.2 million from $71.8 million to $56.6 million during the year ended December 31, 2012, as compared to the year ended December 31, 2011. The decrease in expenses in 2012 related primarily to:

(i) a decrease in legal and professional fees of $10.9 million due largely to

higher 2011 legal fees and settlement costs associated with certain

litigation that did not recur in 2012 along with reductions in audit,

        actuarial and consulting fees of approximately $4.0 million; and    

(ii) a reduction in bank costs of $5.6 million as a result of fewer costs

associated with credit facility fees and letters of credit.

   For 2013, we expect general and administrative expenses to increase over 2012 levels due primarily to the recently completed SeaBright acquisition and the pending acquisition of the HSBC Insurance Companies.  

Comparison of Years Ended December 31, 2011 and 2010

General and administrative expenses increased by $12.6 million from $59.2 million to $71.8 million during the year ended December 31, 2011, as compared to the year ended December 31, 2010. The increased expenses in 2011 related primarily to:

(i) increased bank costs of $5.2 million primarily associated with the costs

of establishing and maintaining our letters of credit, along with the

arrangement and agency fees paid in relation to the establishment of both

        our Clarendon and revolving credit facilities;    

(ii) additional general and administrative expenses of $4.1 million incurred

          in relation to both new acquisitions and significant new business that we          completed in 2011;                                            82 

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(iii) increased legal expenses of approximately $9.7 million due primarily to

legal fees and settlement costs associated with certain litigation and

          legal fees associated with ongoing due diligence projects; and    

(iv) an increase in actuarial consulting fees of approximately $2.9 million

         due to costs associated with ongoing and completed due diligence          projects; partially offset by    

(v) a reduction in general and administrative expense of $9.2 million related

to: (a) the recovery of $5.8 million on a previously written-off asset;

(b) the release of $2.4 million related to provisions on certain other

assets; and (c) savings of $1.0 million associated with the settlement of

other liabilities below their carried amount.

  Interest Expense:                                            Years Ended December 31,                        2012       Variance       2011        Variance        2010                                      (in thousands of U.S. dollars)               Total   $ 8,426     $     103     $ 8,529     $    1,724     $ 10,253   

Comparison of Years Ended December 31, 2012 and 2011

  Interest expense of $8.4 million and $8.5 million was recorded for the years ended December 31, 2012 and 2011, respectively. The decrease in interest expense was attributable primarily to the lower interest rates on the loan facilities outstanding during the year ended December 31, 2012 as compared to the same period in 2011.  For 2013, we expect interest expense increase over 2012 levels due primarily to the increase in loans payable as a result of the borrowings under the SeaBright Facility on February 5, 2013 in connection with our acquisition of SeaBright along with additional borrowings in respect of the planned acquisition of the HSBC Insurance Companies.  

Comparison of Years Ended December 31, 2011 and 2010

  Interest expense of $8.5 million and $10.5 million was recorded for the years ended December 31, 2011 and 2010, respectively. The decrease in interest expense was attributable primarily to the lower interest rates on the loan facilities outstanding during the year ended December 31, 2011 as compared to the same period in 2010.  Income Tax Expense:                                            Years Ended December 31,                        2012       Variance         2011       Variance        2010                                      (in thousands of U.S. dollars)              Total   $ 44,290     $ (19,006 )    $ 25,284     $  61,848     $ 87,132   

Comparison of Years Ended December 31, 2012 and 2011

We recorded income tax expense of $44.3 million and $25.3 million for the years ended December 31, 2012 and 2011, respectively.

  Income tax expense is generated through our foreign operations outside of Bermuda, principally in the United States, Europe and Australia. The effective tax rate was 18.8% for the year ended December 31, 2012 compared with 10.8% in the year ended December 31, 2011. Our effective income tax rate may fluctuate significantly from period to period depending on the geographic distribution of pre-tax net income in any given period between different jurisdictions with different tax rates. Our tax expense increased by $19.0 million for the year ended December 31, 2012 due principally to increased taxable earnings from our U.K.-based subsidiaries.                                           83 

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Comparison of Years Ended December 31, 2011 and 2010

We recorded income tax expense of $25.3 million and $87.1 million for the years ended December 31, 2011 and 2010, respectively.

The decrease in taxes of $61.8 million was due primarily to the combination of:

(i) lower overall net earnings in our tax paying subsidiaries for the year

ended December 31, 2011 as compared to those earned in the same period in

        2010; and         (ii) during 2010, in order to mitigate the tax impacts of inter-group

transactions, the boards of our Australian group of companies elected to

form a consolidated tax group. The impact of this tax consolidation

resulted in resetting the cost basis of certain assets, which resulted in

us recording a tax charge in 2010 of approximately $30.3 million.

Share of Net Earnings of Equity Method Investee:

                                         Years Ended December 31,                         2012      Variance      2011      Variance         2010                                      (in thousands of U.S. dollars)                 Total   $   -     $       -     $   -     $ (10,704 )    $ 10,704    For the year ended December 31, 2010, we recorded $10.7 million as our share of net earnings of our equity method investee. During 2010, we disposed of our 44.4% indirect interest in Stonewall Insurance Company and we acquired a 100% interest in Seaton Insurance Company.  Noncontrolling interest:                                            Years Ended December 31,                        2012       Variance        2011       Variance         2010                                      (in thousands of U.S. dollars)              Total   $ 23,502     $  31,263     $ 54,765     $ (13,120 )    $ 41,645   

Comparison of Years Ended December 31, 2012 and 2011

  We recorded a noncontrolling interest in earnings of $23.5 million and $54.8 million for the years ended December 31, 2012 and 2011, respectively. The decrease for the year ended December 31, 2012 was due primarily to the decrease in earnings for those companies where there exists a noncontrolling interest. In addition, on January 1, 2012, S2008 transferred the assets and liabilities relating to its 2009 and prior underwriting years of account into its 2010 underwriting year of account by means of an RITC transaction. Following the transfer, the existing noncontrolling interest held by JCF FPK and JCF II ceased, resulting in us now providing 100% of the underwriting capacity for S2008. The number of subsidiaries with a noncontrolling interest decreased from 8 as at December 31, 2011 to 7 as at December 31, 2012.  

Comparison of Years Ended December 31, 2011 and 2010

  We recorded a noncontrolling interest in earnings of $54.8 million and $41.6 million for the years ended December 31, 2011 and 2010, respectively. The increase of $13.1 million for the year ended December 31, 2011 was due primarily to the increase in earnings for those companies where there exists a noncontrolling interest.                                           84 

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Liquidity and Capital Resources

  Our capital management strategy is to preserve sufficient capital to enable us to make future acquisitions while maintaining a conservative investment strategy. As we are a holding company and have no substantial operations of our own, our assets consist primarily of investments in subsidiaries. The potential sources of the cash flows to Enstar as a holding company consist of dividends, advances and loans from our subsidiary companies.  Our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends and make other distributions is limited by the applicable laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries operate, including Bermuda, the United Kingdom, the United States, Australia and Europe, which subject these subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, certain of our insurance and reinsurance subsidiaries to maintain minimum capital resources requirements and limit the amount of dividends and other payments that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments. For more information on these laws and regulations, see "Business - Regulation" beginning on page 20.  As of December 31, 2012 and 2011, all of our insurance and reinsurance subsidiaries' capital resources levels were in excess of the minimum levels required, with the exception of one of our U.S. insurance companies that was acquired whilst under supervision and is not in compliance with its minimum risk-based capital level. We do not believe this company's non-compliance will have an impact on our ability to meet our cash obligations. In addition, our subsidiaries' ability to pay dividends and make other forms of distributions may be further limited by repayment obligations in certain of our outstanding loan facility agreements.  We believe that restrictions on liquidity resulting from restrictions on the payments of dividends by our subsidiary companies will not have a material impact on our ability to meet our cash obligations. Retained earnings of our insurance and reinsurance subsidiaries are not currently restricted as minimum capital solvency margins are covered by share capital and additional paid-in-capital.  Our sources of funds primarily consist of the cash and investment portfolios acquired on the completion of the acquisition of an insurance or reinsurance company in run-off. These acquired cash and investment balances are classified as cash provided by investing activities. We expect to use these funds acquired, together with collections from reinsurance debtors, consulting income, investment income and proceeds from sales and redemptions of investments, to meet expected claims payments and operational expenses with the remainder used for acquisitions and additional investments. We expect a net use of cash from operations as total net claim payments and operating expenses will generally be in excess of investment income earned. We expect our operating cash flows, together with our existing capital base and cash and investments acquired on the acquisition of our insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate our business. We currently do not intend to pay dividends on our ordinary shares.  At December 31, 2012, we had total cash and cash equivalents, restricted cash and cash equivalents and investments of $4.31 billion, compared to $4.56 billion at December 31, 2011. Our cash and cash equivalent portfolio is comprised mainly of cash, high-grade fixed deposits, commercial paper with maturities of less than three months and money market funds.  

Reinsurance Recoverables

  Our acquired insurance and reinsurance subsidiaries, prior to acquisition by us, used retrocessional agreements to reduce their exposure to the risk of reinsurance assumed. We remain liable to the extent that retrocessionaires do not meet their obligations under these agreements, and therefore, we evaluate and monitor concentration of credit risk. Provisions are made for amounts considered potentially uncollectible.                                           85

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  As of December 31, 2012 and 2011, we had total reinsurance balances recoverable of $1.12 billion and $1.79 billion, respectively. The decrease of $666.7 million in total reinsurance balances recoverable was primarily a result of commutations, cash collections and a reduction in estimated ultimate losses in the year ended December 31, 2012. At December 31, 2012 and 2011, the provision for uncollectible reinsurance recoverable relating to total reinsurance balances recoverable was $343.9 million and $341.1 million, respectively. To estimate the provision for uncollectible reinsurance recoverable, the reinsurance balances recoverable are first allocated to applicable reinsurers. As part of this process, ceded IBNR reserves are allocated by reinsurer. The ratio of the provision for uncollectible reinsurance recoverable to total reinsurance balances recoverable (excluding provision for uncollectible reinsurance recoverable) as of December 31, 2012 increased to 23.4% as compared to 16.0% as of December 31, 2011. This was primarily as a result of commutations and the collection of reinsurance balances recoverable against which there were minimal provisions for uncollectible reinsurance recoverable.  

Cash Flows

We primarily generate our cash from the acquisitions we complete. These acquired cash and investment balances are classified as cash provided by investing activities.

We expect the net operating cash flows for us, to expiry, to be negative as we pay out cash in claims payments and operational expenses in excess of cash generated via investment income and consulting fees.

The following table summarizes our consolidated cash flows from operating, investing and financing activities in the last three years:

                                                             Years Ended December 31, Total cash (used in) provided by:                2012              2011              2010                                                       (in thousands of U.S. dollars)  Operating activities                          $ (187,350 )      $ (909,920 )      $ (609,211 ) Investing activities                             228,631           691,923           253,461 Financing activities                            (233,773 )         259,769          (124,697 ) Effect of exchange rate changes on cash           (3,092 )           9,548  

13,156

  (Decrease) increase in cash and cash equivalents                                   $ (195,584 )      $   51,320        $ (467,291 )   

See "Item 8. Financial Statements and Supplementary Data - Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010" for further information.

  Operating  Net cash used in our operating activities for the year ended December 31, 2012 was $187.4 million compared to $909.9 million for the year ended December 31, 2011. This $722.6 million decrease in cash used in operating activities was due primarily to the following:   

(i) an increase of $1.0 billion in sales and maturities of trading securities

        between 2011 and 2012;    

(ii) a decrease in reinsurance balances recoverable of $666.8 million in 2012

         compared to a decrease of $238.8 million in 2011;    </pre>
    (iii) an increase of $460.8 million in purchases of trading securities between
          2011 and 2012; and         (iv) an increase in funds held by reinsured companies of $257.5 million in
         2012 compared to a decrease of $167.0 million in 2011, due primarily to
         the RITC transaction completed by S2008 on December 31, 2012.                                            86 
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  Net cash used in our operating activities for the year ended December 31, 2011 was $909.9 million compared to $609.2 million for the year ended December 31, 2010. This $300.7 million increase in cash used in operating activities was due primarily to the following:   
    (i) a decrease of $675.1 million in loss and loss adjustment expense
        liabilities in 2011 compared to an increase of $150.0 million in 2010;    
    (ii) a decrease in reinsurance balances recoverable of $238.8 million in 2011
         compared to an increase of $13.9 million in 2010; and    
    (iii) a decrease in funds held by reinsurance companies of $167.0 million in
          2011 compared to an increase of $206.0 million in 2010.
Investing
Investing cash flows consist primarily of cash acquired net of acquisitions along with net proceeds on the sale and purchase of available-for-sale securities and other investments. Net cash provided by investing activities was $228.6 million during the year ended December 31, 2012 compared to $691.9 million during the year ended December 31, 2011. This $463.3 million decrease in investing cash flows was due primarily to the following:
    (i) a decrease of $73.2 million in restricted cash and cash equivalents during
        2012, compared to a decrease of $290.2 million in 2011;         (ii) a decrease of $91.1 million in the sales and maturities of          available-for-sale securities between 2012 and 2011; and         (iii) an increase of $173.0 million in the funding of other investments           between 2012 and 2011 due to the increased allocation to other           investments during 2012; partially offset by    
    (iv) a decrease of $88.5 million in net cash used for acquisitions between
         2012 and 2011.
   Net cash provided by investing activities was $691.9 million during the year ended December 31, 2011 compared to $253.5 million during the year ended December 31, 2010. This $438.5 million increase in investing cash flows between 2011 and 2010 was due primarily to the following:    
    (i) a decrease of $290.2 million in restricted cash and cash equivalents
        during 2011, compared to an increase of $187.0 million in 2010;    
    (ii) an increase of $92.1 million in the net sales, purchases and maturity of
         available-for-sale and held-to-maturity securities between 2011 and 2010
         due to the decision of our investment committee to increase the          allocation of our investment portfolio to trading securities;    
    (iii) a decrease of $91.9 million in the funding of other investments between
          2011 and 2010 due to higher levels of capital calls related to our           private equity investments during 2010; partially offset by         (iv) the use of $88.5 million in net cash for acquisitions during 2011,          compared to net cash provided by acquisitions of $173.7 million during          2010.   Financing  Net cash (used in) provided by financing activities was $(233.8) million during the year ended December 31, 2012 compared to $259.8 million during the year ended December 31, 2011. This $493.5 million increase in cash used in financing activities was primarily attributable to the following:        (i) $287.4 million in net proceeds from the private placement of shares in
        2011 to affiliates of Goldman, Sachs & Co. compared to $nil in 2012; and
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     (ii) a decrease of $274.2 million in cash received attributable to bank loans          between 2012 and 2011 due largely to decreased acquisition-funding          requirements partially offset by a decrease of $142.9 million in the          repayment of bank loans.   Net cash provided by (used in) financing activities was $259.8 million during the year ended December 31, 2011 compared to $(124.7) million during the year ended December 31, 2010. This $384.5 million increase in cash provided by financing activities was primarily attributable to the following:    
    (i) an increase of $287.4 million in net proceeds from the private placement
        of shares in 2011 to affiliates of Goldman, Sachs & Co. compared to $nil         in 2010; and    
<p>    (ii) an increase of $112.8 million in cash received attributable to bank loans
         between 2011 and 2010 largely due to increased acquisition-funding          requirements, partially offset by an increase of $51.2 million in the          repayment of bank loans; and    
    (iii) a decrease of $41.1 million in dividends paid to noncontrolling interest
          in 2011, partially offset by an increase of $5.6 million in net
          distributions of capital to noncontrolling interest.
Investments
The table below shows the aggregate amounts of our investments as of December 31, 2012 and 2011:
                                               December 31, 2012                     December 31, 2011                                                         % of Total                            % of Total                                      Fair Value         Fair Value         Fair Value         Fair Value                                                         (in thousands of U.S. dollars) U.S. government and agency           $   366,863               10.9 %      $   418,837               12.6 % Non-U.S. government                      389,578               11.6 %          380,778               11.4 % Corporate                              1,715,870               51.2 %        1,968,243               59.0 % Municipal                                 20,446                0.6 %           25,416                0.8 % Residential mortgaged-backed             120,092                3.6 %          110,785                3.3 % Commercial mortgaged-backed              131,329                3.9 %           86,694                2.6 % Asset-backed                              79,264                2.4 %           62,201                1.8 %  Fixed maturities                       2,823,442               84.2 %        3,052,954               91.5 %  Other investments                        414,845               12.4 %          192,264                5.8 % Equities                                 114,588                3.4 %           89,981                2.7 %  Total investments                    $ 3,352,875              100.0 %      $ 3,335,199              100.0 %    As at December 31, 2012, we held investments totaling $3.35 billion, compared to $3.34 billion at December 31, 2011, with net unrealized appreciation included in accumulated other comprehensive income of $5.7 million compared to $16.8 million at December 31, 2011. As at December 31, 2012, we had approximately $1.0 billion of restricted assets compared to approximately $1.2 billion at December 31, 2011.  
We strive to structure our investments in a manner that recognizes our liquidity needs for future liabilities. In that regard, we attempt to correlate the maturity and duration of our investment portfolio to our general liability profile. If our liquidity needs or general liability profile unexpectedly change, we may adjust the structure of our investment portfolio to meet new business needs.
  Our strategy of commuting our liabilities has the potential to accelerate the natural payout of losses. Therefore, we maintain a relatively short-duration investment portfolio in order to provide liquidity for commutation opportunities and avoid having to liquidate longer dated investments. Accordingly, the majority of our investment portfolio consists of highly rated fixed maturities, including U.S. government and agency                                           88
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  investments, highly rated sovereign and supranational investments, high-grade corporate investments, and mortgage-backed and asset-backed investments. We allocate a portion of our investment portfolio to other investments, including private equity funds, fixed income funds, fixed income hedge funds, an equity fund and a real estate debt fund. At December 31, 2012, these other investments totaled $414.8 million, or 12.4%, of our total investments (2011: $192.3 million or 5.8%). The trend of increased allocation to our other investments is likely to continue in the future because we have not fully funded all existing investment commitments in this asset class.  
Fixed Maturity Investments
Our investment guidelines govern the types of investments we make, including with respect to credit quality ratings.
The maturity distribution for our fixed maturity investments held as of December 31, 2012 and 2011 was as follows:
                                                  December 31, 2012               December 31, 2011                                                               % of                            % of                                            Fair Value         Total        Fair Value         Total                                                         (in thousands of U.S. dollars) Due in one year or less                    $ 1,032,614          36.6 %     $ 1,158,546          38.0 % Due after one year through five years        1,342,257          47.5 %       1,465,176          48.0 % Due after five years through ten years          99,957           3.5 %         152,829           5.0 % Due after ten years                             17,929           0.6 %          16,723           0.6 %                                               2,492,757          88.2 %       2,793,274          91.6 % Residential mortgage-backed                    120,092           4.3 %         110,785           3.6 % Commercial mortgage-backed                     131,329           4.7 %          86,694           2.8 % Asset-backed                                    79,264           2.8 %          62,201           2.0 %  Total                                      $ 2,823,442         100.0 %     $ 3,052,954         100.0 %    As at December 31, 2012 and 2011, our fixed maturity investments and short-term investment portfolio had an average credit quality rating of AA-. At December 31, 2012 and 2011, our fixed maturity investments rated BBB or lower comprised 11.3% and 11.5% of our total investment portfolio, respectively.  At December 31, 2012, we had $319.1 million of short-term investments (2011: $410.3 million). Short-term investments are managed as part of our investment portfolio and have a maturity of one year or less when purchased. Short-term investments are carried at fair value.                                           89
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  The following table summarizes the composition of the amortized cost and fair value of our fixed maturity investments, short term investments and other investments at the date indicated by ratings as assigned by major rating agencies.                                                                                                                                                                          Non-                                            Amortized          Fair           % of Total            AAA              AA                A              BBB           Investment           Not At December 31, 2012                         Cost             Value          Investments          Rated            Rated            Rated           Rated            Grade             Rated                                                                            
                         (in thousands of U.S. dollars)
Fixed maturity investments U.S. government & agency                  $   362,288      $   366,863               10.9 %     $       -       $   366,863       $       -       $       -       $          -       $       - Non-U.S. government                           380,401          389,578     
         11.6 %       244,366           103,515          39,051           2,646                  -               - Corporate                                   1,694,652        1,715,870               51.2 %       140,708           434,903         803,663         301,787             27,409           7,400 Municipal                                      19,743           20,446                0.6 %             -            14,470           5,837             139                  -               - Residential mortgage- backed                                        119,538          120,092                3.6 %        17,218            81,253           2,858          16,940              1,823               - Commercial mortgage- backed                                        130,841          131,329                3.9 %        62,597             9,828          29,884          21,406              7,614               - Asset-backed                                   78,644           79,264                2.4 %        64,237             8,177           5,070             174              1,606               - 
Total fixed maturity investments          $ 2,786,107        2,823,442     
          84.2 %       529,126         1,019,009         886,363         343,092             38,452           7,400                                                                                                       18.7 %            36.1 %          31.4 %          12.2 %              1.4 %           0.2 %  Equities U.S.                                                            92,406                2.8 %             -                 -               -               -                  -          92,406 International                                                   22,182                0.6 %             -                 -               -               -                  -          22,182  Total equities                                                 114,588                3.4 %             -                 -               -               -                  -         114,588                                                                                                        0.0 %             0.0 %           0.0 %           0.0 %              0.0 %           100 %  Other investments Private equity funds                                           127,696                3.8 %             -                 -               -               -                  -         127,696 Fixed income funds                                             156,235                4.7 %             -                 -               -               -                  -         156,235 Fixed income hedge funds                                        53,933                1.6 %             -                 -               -               -                  -          53,933 Equity fund                                                     55,881                1.7 %             -                 -               -               -                  -          55,881 Real estate debt fund                                           16,179                0.5 %             -                 -               -               -                  -          16,179 Other                                                            4,921                0.1 %             -                 -               -               -                  -           4,921  Total other investments                                        414,845               12.4 %             -                 -               -               -                  -         414,845                                                                                                        0.0 %             0.0 %           0.0 %           0.0 %              0.0 %           100 %  Total investments                                          $ 3,352,875              100.0 %     $ 529,126       $ 1,019,009       $ 886,363       $ 343,092       $     38,452       $ 536,833                                                                                                       15.8 %            30.4 %          26.5 %          10.2 %              1.1 %          16.0 %                                            90 
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Total fixed maturity investments       3,035,230        3,052,954          
    91.6 %       1,096,824         533,365         1,011,833         377,039              7,794          26,099                                                                                                    35.9 %          17.5 %            33.1 %          12.3 %              0.3 %           0.9 % Equities U.S.                                                       54,378                1.6 %               -               -                 -               -                  -          54,378 International                                              35,603                1.1 %               -               -                 -               -                  -          35,603  Total equities                                             89,981                2.7 %               -               -                 -               -                  -          89,981                                                                                                     0.0 %           0.0 %             0.0 %           0.0 %              0.0 %         100.0 %
Other investments Private equity funds                                      107,388                3.2 %               -               -                 -               -                  -         107,388 Fixed income funds                                         54,537                1.6 %               -               -                 -               -                  -          54,537 Fixed income hedge funds                                   24,395                0.7 %               -               -                 -               -                  -          24,395 Other                                                       5,944                0.2 %               -               -                 -               -                  -           5,944  Total other investments                                   192,264                5.7 %               -               -                 -               -                  -         192,264                                                                                                     0.0 %           0.0 %             0.0 %           0.0 %              0.0 %         100.0 %  Total investments                                     $ 3,335,199              100.0 %     $ 1,096,824       $ 533,365       $ 1,011,833       $ 377,039       $      7,794       $ 308,344                                                                                                    32.9 %          16.0 %            30.3 %          11.3 %              0.2 %           9.3 %  
The value of our fixed maturity investments will fluctuate with changes in the interest rate environment and when changes occur in the overall investment market and in overall economic conditions.
Our fixed maturity portfolio is managed by our Chief Investment Officer and outside investment advisors with oversight from our Investment Committee.
  As at December 31, 2012 and 2011, no investments were considered other-than-temporarily impaired. At December 31, 2012, our gross unrealized losses on available-for-sale investments totaled $0.7 million. At December 31, 2012, we held 23 available-for-sale investments that were in an unrealized loss position for longer than twelve months.                                           91
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Other Investments
The table below shows the fair value of our portfolio of other investments held at December 31, 2012 and 2011:
                                               Total                Total                                           Fair Value           Fair Value                                              2012                 2011                                          (in thousands of U.S. dollars)             Private equity funds       $        127,696       $    107,388             Fixed income funds                  156,235             54,537             Fixed income hedge funds             53,933             24,395             Equity fund                          55,881                  -             Real estate debt fund                16,179                  -             Other                                 4,921              5,944              Total other investments    $        414,845       $    192,264    We have committed capital to other investments of $87.6 million as at December 31, 2012 and $77.5 million as at December 31, 2011. In the future, we may enter into additional commitments in respect of private equity partnerships or individual portfolio company investment opportunities.  
Measuring the Fair Value of Other Investments using Net Asset Valuations
  The following table presents the fair value, unfunded commitments and redemption frequency for all of our other investments. These investments are all valued at net asset value as at December 31, 2012.                                                               Investments                                          Gated/              without                         Total             Side              Gates or                         Fair             Pocket               Side              Unfunded            Redemption                         Value          Investments           Pockets           Commitments           Frequency Private equity funds                 $ 127,696       $           -       $     127,696       $      86,936       Not eligible Fixed income                                                                                      Daily to funds                   156,235                   -             156,235                   -       monthly Fixed income             53,933                   -              53,933                   -       Quarterly after hedge funds                                                                                       lock-up periods                                                                                                   expire Equity fund              55,881                   -              55,881                   -       Bi-monthly Real estate debt         16,179                   -              16,179                   - fund                                                                                              monthly Other                     4,921                   -               4,921                 655       Not eligible  Total                 $ 414,845       $           -       $     414,845       $      87,591   
Management regularly reviews and discusses fund performance with their fund managers to corroborate the reasonableness of the reported net asset values and to assess whether any events have occurred within the lag period that would materially affect the valuation of the investments.
Private equity funds
  This class is comprised of several private equity funds that invest primarily in the financial services industry. All of our investments in private equity funds are subject to restrictions on redemptions and sales that are determined by the governing documents and limit our ability to liquidate those investments. These restrictions have been in place since the dates the initial investments were made.  
As of December 31, 2012 and 2011, we had  and $107.4 million, respectively, of other investments recorded in private equity funds, which represented 3.8% and 3.2% of total investments, respectively.
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Fixed income funds
  This class is comprised of a number of positions in diversified fixed income funds that are managed by third party managers. Underlying investments vary from high grade corporate bonds to below investment grade senior secured loans and bonds, but are generally invested in liquid fixed income markets. These funds have regularly published prices. The funds have liquidity terms that vary from daily to monthly.  Fixed income hedge funds  This class is comprised of hedge funds that invest in a diversified portfolio of debt investments. The advisor of the funds intends to seek attractive risk-adjusted total returns for the funds' investors by acquiring, originating, and actively managing a diversified portfolio of debt investments, with a focus on various forms of mortgage-backed investments and loans. The funds focus on investments that the advisor believes to be fundamentally undervalued with current market prices that are believed to be compelling relative to intrinsic value. The hedge funds are not currently eligible for redemption due to imposed lock-up periods of three years from the time of our initial investment. Once eligible, redemptions will be permitted quarterly with 90 days' notice. The first eligible redemption is March 2014.  
Equity fund
  This class is comprised of an equity fund that invests in a diversified portfolio of international publicly-traded equity investments. The manager of the fund seeks to maximize the intrinsic value of the portfolio by focusing on price and quality.  Real estate debt fund  This class is comprised of a real estate debt fund that invests primarily in U.S. commercial real estate loans and securities. A redemption request for this fund can be made 10 days after the date of any monthly valuation; the fund states that it will make commercially reasonable efforts to redeem the investment within the next monthly period.  
Other
  This class is comprised primarily of a fund that provides loans to educational institutions throughout the U.S. and its territories. Through this investment we participate in the performance of the underlying loans. This investment matures when the loans are paid down.                                           93
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Eurozone Exposure
  At December 31, 2012, we did not own any investments in fixed maturity investments (which includes bonds that are classified as cash and cash equivalents) and fixed income funds issued by the sovereign governments of Portugal, Italy, Ireland, Greece or Spain. Our fixed maturity investments and fixed income funds exposures to Eurozone Governments (which includes regional and municipal governments including guaranteed agencies) by rating are highlighted in the following tables:                                                                   Ratings                                                                             BBB and                                         AAA           AA           A         below         NR          Total                                                            (in thousands of U.S. dollars) Germany                               $ 33,067     $ 12,567     $     -     $      -     $     -     $  45,634 Supranationals                          30,696          901           -            -           -        31,597 Denmark                                  1,560            -           -            -           -         1,560 Netherlands                             15,669        2,485           -            -           -        18,154 Norway                                   2,316        4,206           -       26,492           -        33,014 France                                       -       14,462           -            -           -        14,462 Finland                                    493            -           -            -           -           493 Sweden                                   1,998       20,293       4,780            -           -        27,071 Austria                                      -       11,461           -            -           -        11,461                                          85,799       66,375       4,780       26,492           -       183,446 Euro Region Government Funds             4,922            -          71        6,291       1,094        12,378                                        $ 90,721     $ 66,375     $ 4,851     $ 32,783     $ 1,094     $ 195,824    Our fixed maturities exposure to Eurozone Governments (which include regional and municipal governments including guaranteed agencies) by maturity date are highlighted in the following table. Our fixed income fund holdings have daily liquidity and are not included in the maturity table below.                                                By Maturity Date                   3 months       3 to 6       6 months        1 to 2       more than 2                    or less       months       to 1 year       years           years           Total                                             (in thousands of U.S. dollars)  Germany          $  10,813     $  2,000     $     5,076     $  1,089     $      26,656     $  45,634  Supranationals           -        7,040          17,388        2,481             4,688        31,597  Denmark                  -            -           1,560            -                 -         1,560  Netherlands              -        5,001           4,331        3,732             5,090        18,154  Norway               1,000       17,394               -            -            14,620        33,014  France                   -            -          10,877          480             3,105        14,462  Finland                  -            -               -          493                 -           493  Sweden               8,612            -           3,385        7,072             8,002        27,071  Austria             10,026            -               -          490               945        11,461                    $  30,451     $ 31,435     $    42,617     $ 15,837     $      63,106     $ 183,446                                             94 
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At December 31, 2012, we owned investments in corporate securities (which include bonds that are classified as cash and cash equivalents) where the ultimate parent company of the issuer was located within the Eurozone. This includes investments that were issued by subsidiaries whose location was outside of the Eurozone. Our exposures by country and listed by rating, sector and maturity date are highlighted in the following tables:
                                                            Ratings                                                                                      BB and                                AAA             AA             A           BBB         below        Total                                                     (in thousands of U.S. dollars) Germany                      $      -     $          -     $ 10,514     $      -     $     -     $  10,514 Belgium                            -                -         6,692           -           -          6,692 Netherlands                       335           20,093       13,680       58,884         540        93,532 Sweden                             -             2,728       13,719           -        7,360        23,807 Norway                         12,622               -         3,518           -           -         16,140 France                         21,321            8,532       18,440        1,085          -         49,378 Spain                              -             2,932           -        20,376          -         23,308 Italy                              -                -            -         1,026          -          1,026 Luxembourg                         -                -         1,121       14,871          -         15,992                               $ 34,278     $     34,285     $ 67,684     $ 96,242     $ 7,900     $ 240,389                                                     Sector               Financial       Energy       Industrial      Telecom      Utility       Other        Total                                              (in thousands of U.S. dollars) Germany       $    8,274     $      -     $      2,240     $      -     $      -     $     -     $  10,514 Belgium            6,427            -              265            -            -           -         6,692 Netherlands       55,761       10,471            5,319        8,856       13,125           -        93,532 Sweden            16,447            -            4,140            -            -       3,220        23,807 Norway            12,622            -            3,518            -            -           -        16,140 France            35,283            -            8,041          700        5,354           -        49,378 Spain              2,932            -           20,376            -            -           -        23,308 Italy              1,026            -                -            -            -           -         1,026 Luxembourg         1,120          704                -        8,479        5,689           -        15,992                $  139,892     $ 11,175     $     43,899     $ 18,035     $ 24,168     $ 3,220     $ 240,389                                                 By Maturity Date                                                                              more                    3 months       3 to 6       6 months        1 to 2       than 2                     or less       months       to 1 year       years        years         Total                                            (in thousands of U.S. dollars)      Germany       $   2,240     $  5,087     $         -     $  2,658     $    529     $  10,514      Belgium             265            -               -            -        6,427         6,692      Netherlands      12,896       10,800          16,394       18,756       34,686        93,532      Sweden           14,065        2,296           4,000        2,014        1,432        23,807      Norway            3,518            -               -       12,622            -        16,140      France            5,289        5,198           4,241       10,866       23,784        49,378      Spain            15,052        8,256               -            -            -        23,308      Italy                 -            -             528            -          498         1,026      Luxembourg        5,688            -           7,492        2,812            -        15,992                     $  59,013     $ 31,637     $    32,655     $ 49,728     $ 67,356     $ 240,389   
Investments issued by companies located in the United Kingdom and Switzerland are not included in the tables.
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None of the investments we owned at December 31, 2012 were considered impaired and we do not expect to incur any significant losses on these investments.
Long-Term Debt
  Our long-term debt consists of loan facilities used to partially finance certain of our acquisitions or significant new business transactions. We draw down on the loan facilities at the time of the acquisition or significant new business transaction, although in some circumstances we have made additional draw-downs to refinance existing debt of the acquired company. Until they were fully repaid on December 3, 2012, we also had loans outstanding relating to the share repurchase agreements described below.  For the years ended December 31, 2012, 2011 and 2010, we incurred interest expense of $8.4 million, $8.5 million and $10.3 million, respectively, on our loan facilities and loans related to the share repurchase agreements. All of our currently outstanding loan facilities are floating rate loans, and the fair values of these loans approximate their book values.  Amounts of loans payable outstanding, and accrued interest, as of December 31, 2012 and 2011 totaled $107.4 million and $242.7 million, respectively, and were comprised of:                                                                    Facility Facility                    Date of Facility       Term          Amount         December 31, 2012        December 31, 2011 EGL Revolving Credit Facility                    June 14, 2011          3 Years      $ 250,000      $                 -      $           115,875 Clarendon Facility          July 12, 2011          4 Years      $ 106,500                  106,500                  106,500 SeaBright Facility          December 21, 2012      4 Years      $ 111,000                        -                        -  Total long-term bank debt                                                                                       106,500                  222,375 Repurchase agreements       October 1, 2010                                                      -                   18,667 Accrued interest on loans payable                                                                                  930                    1,668  Total loans payable                                                            $           107,430      $           242,710    EGL Revolving Credit Facility  On June 14, 2011, we, as borrower, and certain of our subsidiaries, as guarantors, entered into a Revolving Credit Facility Agreement with NAB and Barclays, as bookrunners and mandated lead arrangers, certain financial institutions, as lenders, and NAB as agent, or the EGL Revolving Credit Facility. The EGL Revolving Credit Facility provides for a three-year revolving credit facility pursuant to which we are permitted to borrow up to an aggregate of $250.0 million, which is available to prepay certain existing credit facilities of ours and certain of our subsidiaries, to fund permitted acquisitions and for general corporate purposes. Our ability to draw on the EGL Revolving Credit Facility is subject to customary conditions.  The EGL Revolving Credit Facility is secured by a first priority lien on the stock of certain of our subsidiaries and certain bank accounts held with Barclays in our name and into which amounts received in respect of any capital release from certain of our subsidiaries are required to be paid. Interest is payable at the end of each interest period chosen by us or, at the latest, each six months. The interest rate is LIBOR plus 2.75%, plus an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. Any unused portion of the EGL Revolving Credit Facility is subject to a commitment fee of 1.10%. The EGL Revolving Credit Facility is subject to various financial and business covenants applicable to us, the guarantors and certain other material subsidiaries, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and dividends, and limitations on liens on stock. As of December 31, 2012, all of the covenants relating to the EGL Revolving Credit Facility were met.                                           96 
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  During the existence of any payment default, the interest rate is increased by 1.0%. During the existence of any event of default (as specified in the EGL Revolving Credit Facility), the agent may cancel the commitments of the lenders, declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of outstanding amounts payable upon demand or proceed against the security. The EGL Revolving Credit Facility terminates and all amounts borrowed must be repaid on June 14, 2014, the third anniversary of the facility.  On October 21, 2011 and December 30, 2011, we repaid $25.0 million and $26.8 million, respectively, of the outstanding principal balance of the EGL Revolving Credit Facility. On June 29, 2012, we repaid $115.9 million of the outstanding principal balance and $2.1 million of accrued interest on the facility. As of December 31, 2012, the outstanding EGL Revolving Credit Facility loan balance, inclusive of accrued interest, was $nil. On February 5, 2013, we borrowed $56.0 million under the EGL Revolving Credit Facility.  
Clarendon Facility
  On March 4, 2011, we, through Clarendon Holdings, Inc., entered into a $106.5 million term facility agreement, or the Clarendon Facility, with NAB. The Clarendon Facility provides a four-year term loan facility, which was fully drawn upon on July 12, 2011 to fund 50% of the purchase price of Clarendon. As of December 31, 2012, the outstanding Clarendon Facility principal balance was $106.5 million.  The Clarendon Facility is secured by a security interest in all of the assets of Clarendon Holdings, Inc., as well as a first priority lien on the stock of both Clarendon Holdings, Inc. and Clarendon. Interest is payable at the end of each interest period chosen by Clarendon Holdings, Inc. or, at the latest, each six months. The interest rate is LIBOR plus 2.75%. The Clarendon Facility is subject to various financial and business covenants, including limitations on mergers and consolidations, restrictions as to disposition of stock and limitations on liens on the stock.  During the existence of any payment default, the interest rate is increased by 1.0%. During the existence of any event of default (as specified in the term facility agreement), the lenders may declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of borrowed amounts payable upon demand, or proceed against the security. The Clarendon Facility terminates and all amounts borrowed must be repaid on July 12, 2015.  
SeaBright Facility
  On December 21, 2012, we, through AML Acquisition, entered into a Term Facility Agreement with NAB and Barclays, or the SeaBright Facility. The SeaBright Facility provides a four-year term loan facility, which AML Acquisition fully drew down on February 5, 2013 in an amount of $111.0 million to partially fund our acquisition of SeaBright. We acquired SeaBright on February 7, 2013 by way of a merger of AML Acquisition with and into SeaBright, or the Merger, with SeaBright surviving the Merger as our indirect, wholly-owned subsidiary.  Following completion of the Merger, SeaBright (as the survivor of the Merger) became the borrower under the SeaBright Facility and the facility became secured by a security interest in all of the assets of SeaBright, a pledge of the stock of SeaBright by its sole stockholder, a pledge of the stock of SeaBright Insurance Company, Paladin Managed Care Services, Inc., and PointSure Insurance Services, Inc. (which are wholly-owned subsidiaries of SeaBright) by SeaBright, and a security interest in all of the assets of Paladin Managed Care Services, Inc. and PointSure Insurance Services, Inc.  From the date of the SeaBright Facility until the draw down on February 5, 2013, the undrawn and uncancelled amount of the SeaBright Facility incurred a fee of 1% per annum. Interest on amounts borrowed under the SeaBright Facility is payable at the end of each interest period chosen by the borrower or, at the latest,                                           97 
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  each six months. The interest rate is LIBOR plus 2.75% for the first 18 months from February 5, 2013, and increases to LIBOR plus 3.50% thereafter; the interest rate is subject to increase by an incremental amount tied to certain regulatory costs, if any, that may be incurred by the lenders. The SeaBright Facility imposes various financial and business covenants on SeaBright, including limitations on mergers and consolidations, acquisitions, indebtedness and guarantees, restrictions as to dispositions of stock and assets (except for certain permitted dispositions), restrictions on dividends, and limitations on liens on the stock.  During the existence of any payment default, the interest rate would be increased by 1.0%. During the existence of any event of default (as specified in the SeaBright Facility), the lenders may cancel their commitments, declare all or a portion of outstanding amounts immediately due and payable, declare all or a portion of borrowed amounts payable upon demand, or proceed against the security. The SeaBright Facility terminates and all amounts borrowed must be repaid on December 21, 2016, the fourth anniversary of the date the facility was put in place.    Share Repurchase  On October 1, 2010, we entered into repurchase agreements to repurchase an aggregate of 800,000 of our ordinary shares at a price of $70.00 per share from three of our executives and certain trusts and a corporation affiliated with the executives. The aggregate purchase price of $56.0 million was payable through promissory notes to the selling shareholders. The annual interest rate on the promissory notes was fixed at 3.5%, and the notes were repayable in three equal installments on December 31, 2010, December 1, 2011 and December 1, 2012. On December 1, 2012, we fully repaid the outstanding amount of $19.3 million under the promissory notes, inclusive of accrued interest, relating to the share repurchase.  
Investment by Affiliates of Goldman Sachs in 2011
  On April 20, 2011, we entered into an Investment Agreement with GSCP VI AIV Navi, Ltd., GSCP VI Offshore Navi, Ltd., GSCP VI Parallel AIV Navi, Ltd., GSCP VI Employee Navi, Ltd., and GSCP VI GmbH Navi, L.P., or collectively, the Purchasers, each of which is an affiliate of Goldman, Sachs & Co. Under the Investment Agreement, we agreed to issue and sell, and the Purchasers agreed to purchase, at three different closings that occurred during 2011, securities representing 19.9% of our outstanding share capital pro forma for all the issuances, with the right to acquire an additional 2.0% on a fully diluted basis pro forma for all the issuances through the exercise of warrants as described below, although the Purchasers' voting interest purchased pursuant to the Investment Agreement is less than 4.9%. The total investment made by the Purchasers was $291.6 million, and we received net proceeds (after transaction costs) of approximately $287.4 million.  
Aggregate Contractual Obligations
  The following table shows our aggregate contractual obligations and commitments by time period remaining to due date as at December 31, 2012. The table does not reflect certain acquisition-related payments potentially due in the future.                                                                    Payments Due by Period                                                         Less than         1 - 3         3 - 5       More than                                           Total          1 year           years         years        5 years                                                             (in thousands of U.S. dollars) Operating Activities Estimated gross reserves for loss and loss adjustment expenses            $ 3,957.7      $     686.1      $ 1,255.0      $ 714.4      $  1,302.2 Operating lease obligations                  15.4              4.8            9.9          0.7               - Investing Activities Investment commitments                       87.6             47.7           31.6          8.3               - Financing Activities Loan repayments (including interest payments)                                   111.0             56.0           55.0            -               -  Total                                   $ 4,171.7      $     794.6      $ 1,351.5      $ 723.4      $  1,302.2                                             98 
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  The reserves for loss and loss adjustment expenses represent management's estimate of the ultimate cost of settling losses. As more fully discussed in"- Critical Accounting Policies - Loss and Loss Adjustment Expenses" above, the estimation of losses is based on various complex and subjective judgments. Actual losses paid may differ, perhaps significantly, from the reserve estimates reflected in our financial statements. Similarly, the timing of payment of our estimated losses is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid in any such period can be significantly different from the amounts disclosed above.  The amounts in the above table represent our estimates of known liabilities as of December 31, 2012 and do not take into account corresponding reinsurance recoverable amounts that would be due to us. Furthermore, reserves for loss and loss adjustment expenses recorded in the audited consolidated financial statements as of December 31, 2012 are computed on a fair value basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect the fair value adjustment in the amount payable.  
Commitments and Contingencies
Investments
The following table provides a summary of our outstanding unfunded investment commitments for the years ended December 31, 2012 and 2011:
                                                   December 31, 2012           December 31, 2011                              Original             Commitment                  Commitment                             Commitment       Funded       Unfunded       Funded       Unfunded                                               (in thousands of U.S. dollars    J.C. Flowers II L.P.    $    100,000     $  97,782     $   2,218     $  97,780     $   2,220    J.C. Flowers III L.P.        100,000        44,373        55,627        30,753        69,247    Other                         51,000        21,254        29,746         9,932         6,068                             $    251,000     $ 163,409     $  87,591     $ 138,465     $  77,535    Guarantees 
As at December 31, 2012 and 2011, we had, in total, parental guarantees supporting Fitzwilliam's obligations in the amount of $213.3 million and $219.9 million, respectively.
  Acquisitions  We have entered into definitive agreements with respect to: (i) the Reciprocal of America loss portfolio transfer, which is expected to close in the second quarter of 2013; (ii) the American Physicians Assurance Corporation assignment and assumption agreement, which is expected to close in the second quarter of 2013; and (iii) the purchase of the HSBC Insurance Companies, which is expected to close by the end of the first quarter of 2013. All three agreements are described in "Business - Recent Transactions - 2013/2012 Acquisitions and Portfolio Transfers" beginning on page 6.  
Legal Proceedings
Refer to "Item 3. Legal Proceedings" for a description of our litigation matters.
Off-Balance Sheet and Special Purpose Entity Arrangements
At December 31, 2012, we do not have any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
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